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Inflation, Still Not Taking Off Anytime Soon

January 15, 2013

So what about the $1 trillion platinum coin, which has been posited as a workaround for the federal debt ceiling?
-Scott Brown, chief economist, Raymond James

A few years ago, amid exceptionally large federal budget deficit and extraordinarily accommodative Fed policy, a number of pundits warned of impending hyperinflation. Instead, inflation has stayed low. That hasn’t stopped the inflation worrywarts. It’s just a matter of time, they say. Inflation “has to show up at some point.” That’s not an argument. There are a number of reasons to expect inflation to stay low.

Inflation is a rise in the general level of prices over time. Hyperinflation is very high inflation. There are dozens of examples throughout history (from Angola to Zimbabwe). At its peak in November 2008, inflation in Zimbabwe averaged nearly 100% per day. As with any high inflation, hyperinflation is caused by excessive growth in the money supply (that is money growing much more rapidly than the growth in goods and services). However, it’s not just money growth that matters. The velocity, or “turnover” of money in the economy is also a key factor. More often than not, hyperinflations are associated with governments printing money to fund their deficits.

Isn’t that what’s going on in the U.S. now? No. The federal government has been borrowing a lot more in recent years and the Federal Reserve has been buying large amounts of that, but these are separate decisions. The government debt that the Fed buys doesn’t go away. Treasury still has to make good on the debt. However, the Fed typically returns some of the interest it earns to the Treasury each year, $88.9 billion just last week.

Many people are upset that the Fed can create money out of thin air. However, the Fed does this all the time in regulating the money supply. The Fed doesn’t actually print money. It simply buys Treasuries and credits the account of the seller, adding to bank reserves, which the banks can then lend out. The banks are the ones effectively “creating” money. Monetary policy works through its influence on loan growth.

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