Hostname: page-component-cd9895bd7-p9bg8 Total loading time: 0 Render date: 2024-12-25T19:29:39.931Z Has data issue: false hasContentIssue false
  • English
  • Français

Quantity Theory of Money Redux? Will Inflation be the Legacy of Quantitative Easing?

Published online by Cambridge University Press:  01 January 2020

William R. Cline
William R. Cline*
Affiliation:
Peterson Institute for International Economics
*
E-mail: MTilghman@PIIE.com
Get access Rights & Permissions [Opens in a new window]

Abstract

Since the onset of the Federal Reserve's unconventional programme of large-scale asset purchases, known as quantitative easing (QE), some economists and financial practitioners have feared that the consequent buildup of the Fed's balance sheet could lead to a large expansion of the money supply, and that such an increase could cause a sharp rise in inflation. So far fears about induced inflation have not been validated. This article examines the basis for the original concerns about inflation in terms of the classic quantity theory of money, which holds that inflation occurs when the money supply expands more rapidly than warranted by increases in real production. The article first reviews the US experience and shows that whereas rapid money growth might have been a plausible explanation of inflation in the 1960s through the early 1980s, subsequent data have not supported such an explanation. It then shows that the quantity theory of money has not really been put to the test after the Great Recession, because a sharp increase in banks’ excess reserves and corresponding sharp decline in the ‘money multiplier’ has meant that the rise in the Federal Reserve's balance sheet has not translated into increased money available to the public in the usual fashion. The most likely aftermath of quantitative easing remains one of benign price behaviour. However, if nascent inflationary conditions materialise, the Federal Reserve will need to manage adroitly the large amounts of banks’ excess reserves that have accumulated as a consequence of QE in order to limit inflationary pressures.

Keywords

excess reservesFederal Reservemoney growthmoney multipliervelocity of moneyE41E50E51E52E58
Type
Research Articles
Information
National Institute Economic Review , Volume 234 , November 2015 , pp. R15 - R26
Copyright
Copyright © 2015 National Institute of Economic and Social Research

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

I thank Abir Varma for research assistance. For comments on an earlier draft, I thank without implicating my colleagues Joseph Gagnon, Paolo Mauro, Avinash Persaud, David Stockton, Edwin M. Truman, and Ángel Ubide.

References

Bernanke, B.S. (2006), ‘Monetary aggregates and monetary policy at the Federal Reserve: a historical perspective’, speech at the Fourth ECB Central Banking Conference, Frankfurt, Germany. Available at: www.federalreserve.gov/newsevents/speech/bernanke20061110a.htm (accessed April 28, 2015).Google Scholar
Blaug, M. (1968), Economic Theory in Retrospect. Homewood, IL: Richard D. Irwin.Google Scholar
Cline, W.R. and Williamson, J. (2009), 2009 Estimates of Fundamental Equilibrium Exchange Rates, Policy Briefs in International Economics 09–10 (June), Washington: Peterson Institute for International Economics.Google Scholar
Congdon, T. (2006), Broad Money vs. Narrow Money: A Discussion Following the Federal Reserve's Decision to Discontinue Publication of M3 Dat, LSE Financial Markets Group Special Paper 166 (May), London: London School of Economics.Google Scholar
European Central Bank (ECB) (2015a), Strategy, Frankfurt.Google Scholar
European Central Bank (ECB) (2015b), Euro Area Monetary Aggregate M3: Annual Growth Rates, Statistical Data Warehouse, Frankfurt.Google Scholar
Federal Reserve (1993), ‘Reserve requirements: history, current practice, and potential reform’, Federal Reserve Bulletin (June), pp. 569–89, Washington.Google Scholar
Federal Reserve (2015a), Policy Normalization Principles and Plans, Washington.Google Scholar
Federal Reserve (2015b), Assets and Liabilities of Commercial Banks in the United States (H.8), Washington.Google Scholar
Federal Reserve (2015c), Reserves of Depository Institutions (H.3), Washington.Google Scholar
Federal Reserve (2015d), Financial Accounts of the United States (Z.1) (March), Washington.CrossRefGoogle Scholar
Federal Reserve (2015e), Selected Interest Rates (H.15), Washington.Google Scholar
Federal Reserve (2015f), Reserve Requirements, Washington.Google Scholar
Federal Reserve (2015g), Foreign Exchange Rates (H.10), Washington.Google Scholar
Federal Reserve (2015h), Term Deposit Facility, Washington.Google Scholar
Federal Reserve (2015i), ‘Why does the Federal Reserve aim for 2 percent inflation over time?’, Current FAQs, Washington.Google Scholar
Federal Reserve Bank of San Francisco (2003), How Did the Fed Change Its Approach to Monetary Policy in the Late 1970s and Early 1980s? (January), San Francisco.Google Scholar
Federal Reserve Bank of St. Louis (2015), ‘Personal consumption expenditures: chain-type price index’, FRED Economic Data. St. Louis.Google Scholar
International Monetary Fund (IMF) (2015a), International Financial Statistics (monthly), Washington.Google Scholar
International Monetary Fund (IMF) (2015b), World Economic Outlook Database, April 2015, Washington.Google Scholar
Sargent, T.J. and Surico, P. (2011), ‘Two illustrations of the quantity theory of money: breakdowns and revivals’, American Economic Review, 101 (February), pp. 109–28.CrossRefGoogle Scholar
Thornton, D.L. (2010), ‘The downside of quantitative easing’, Economic Synopses, 34, Federal Reserve Bank of St. Louis.Google Scholar
Wheelock, D.C. (2009), ‘How not to reduce excess reserves’, Monetary Trends (September), Federal Reserve Bank of St. Louis.Google Scholar