In conclusion, theory and evidence tell me it’s impossible for the Fed to create inflation, no matter how much it tries. The reason is because all the Fed does is shift dollars from one type of account to another, never changing the net financial assets held by the economy. Changing interest rates only shifts dollars between ’savers’ and ‘borrowers’ and QE only shifts dollars from securities accounts to reserve accounts. And so theory and evidence tells us not to expect much change in the macro economy from these primary Fed tools, making it impossible for the Fed to create inflation.
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My comment: The Fed is creating inflation, but it is being offset by deflating asset prices. The author should wait 5 years and still try to make the same argument.
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Update: Here is another argument saying the same thing.
From: http://econviz.org/macroeconomic-balance-sheet-visualizer/
- Quantitative easing simply swaps one type of asset on private sector balance sheets (typically treasuries) for another type (deposits backed by bank reserves, or simply bank reserves if a bank did the selling.)
- QE effectively changes the duration mix of outstanding government liabilities toward more short term liabilities and less long term ones. As such, it is roughly equivalent to if the treasury had previously chosen to issue relatively more T-Bills (short duration) and less bonds (long duration).
- No sectors (or entities within sectors) see any change in balance sheet equity as a direct result of QE. Therefore, there is no meaningful increase in the private sector's purchasing power or propensity to spend. At the level of each individual household or firm who might sell to the Fed during QE, decisions regarding investment portfolio composition tend to be made independently from decisions about how much to spend versus hold in an investment portfolio — so a change in the portfolio mix (cash, bonds, stocks, etc) won't cause more spending. Also, treasuries are almost as liquid as "money" and anyone previously holding treasuries could have easily sold them to support any planned spending.
- The central bank balance sheet expands as it draws in assets from the private sector and creates new liabilities (reserves) to match.
- Modern Monetary Theorists point out that from a macroeconomic perspective, QE includes a deflationary impulse because is it replaces a higher yielding asset (treasuries) with a lower yielding asset (money), reducing the interest income paid to the private sector by the government! As such it is comparable to the removal of some fiscal stimulus, though the extent to which aggregate demand is impacted in each case could differ depending on targeting (i.e., those earning treasury bond income may have a different propensity to spend from the initial recipients of fiscal stimulus related spending.)
- Broad money and base money both increase when households do the selling (however, when banks are the ones deciding to sell treasuries, broad money does not increase). QE does not lead to loan-driven inflation now or in the future, as banks never lend out reserves or are reserve constrained, rather loans create deposits (see "Bank Loan" operation).
- QE is sometimes argued to lead to asset price inflation as the holders of now more numerous low yielding deposits and currency may bid up asset prices (stocks, commodities, real estate, etc) in a search for yield, but whether this leads to inflation in the real economy depends on the extent to which this induces a subsequent and ongoing increase in private sector demand for goods and services. The existence of a transmission mechanism from QE to sustained inflation in goods and services is highly questionable. Any psychology-driven increase in asset price valuation multiples is unlikely to be sustained, since real earnings underlying the assets are unlikely to grow as fast as expected by who assume QE directly stimulates the economy. For example, Japan has engaged in multiple rounds of quantitative easing since the early 2000s with no discernable impacts on the real economy and certainly no growth in inflation (Japan has moved in and out of mild deflation). Japan expert Richard Koo calls QE the "greatest monetary non-event."
- Ultimately, the private sector controls the size of the broad money supply as a consequence of its borrowing decisions and portfolio adjustment decisions. Some theory and evidence support the idea that the private sector can "undo" the increase in deposits that results from QE! See the post "A Visual Guide to Endogenous Money and the Failure of QE" and its predecessors for a detailed explanation.
