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Wednesday, March 04, 2009

How can this NOT be inflationary?

I am not a macroeconomist, nor a monetary theorist, but it is difficult for me to believe that this will not be inflationary:

HT: ChartingStocks.net

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Check out M2 or non-borrowed reserves. Maybe you won't feel much better about things, but the monetary base is pretty bank-reserve biased. The problem with that is that bain's ain't lending due to the whole scared out of their wits thing. Maybe when banks start deciding that they like making money again it will turn inflationary. What about the meantime?
Colleague RRM pointed out the other day that the M1 multiplier was had fallen below one during January. For the uninitiated, that means that for every dollar in banking reserves there is less than a dollar going out the door. That would seem to be an outcome of considerable uncertainty - in future defaults, government action, and just about anything else you can come up with.

If banks just sit on the money, then the ramped up reserves are not necessarily inflationary, if I remember what little of macroeconomics I studied in graduate school. However, this is where the policy gets seemingly contradictory. On the one hand many (including politicians) want the banks to keep/restart lending, which would be potentially inflationary. On the other hand, the banks might need the reserves to keep themselves solvent as future defaults on various forms of credit continue.

Which is the real policy goal and which is the actual policy outcome?
Exactly, and to expound the whole multiplier thing, that means banks are holding onto more than 100% of new injections of new deposits/liquidity, if I remember my grad-school macro.
And you're dead-on with the contradiction: The individually-responsible thing to do might be to hold onto reserves, and heck it might even be just what the system needs, but policymakers, who have a short horizon due to the political cycle, want them to lend, lend, lend.
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