THE STASH JUNE 26, 2009
One camp of critics of the Fed's credit easing policies has argued that the sharp increase in the money supply will lead to much higher inflation down the road.
But with rates on 10-year Treasurys on the decline since early June, the rhetoric from inflation hawks has tapered off. The pullback on both counts is probably related to fresh signs that the global slowdown is still pretty entrenched. The latest evidence being a particularly gloomy forecast from the World Bank this week.
And now some new research from the St. Louis Fed calls into question the whole idea that money supply can predict inflation levels:
This paper provides the most fully comprehensive evidence to date on whether or not monetary aggregates are valuable for forecasting US inflation in the early to mid 2000s. We explore a wide range of different definitions of money, including different methods of aggregation and different collections of included monetary assets...Our findings do not provide much support for the usefulness of monetary aggregates in forecasting inflation. [emphasis added.]
You could quibble that the "early to mid 2000s" was quite a different period than what we're going through now. And some inflation hawks could take the stand that the relationship between money supply and inflation is only evident over long time periods. But that's when you look to Japan, which despite its expansionary monetary policy nearly a decade ago is still battling deflation. From Bloomberg today:
Japan may be sinking into deflation that will undermine the nation’s rebound from its worst postwar recession, the Cabinet Office’s chief economist said.
Finally, Morgan Stanley economist David Greenlaw has this to say about inflation concerns:
While some claim that the jump in yields may be due to Fed credibility concerns, such a perception appears to be based on several myths regarding the Fed balance sheet. Specifically, there are contentions that the Fed is monetizing Treasury debt. Yet, the volume of Treasury securities held by the Fed today is far less than two years ago. Critics of this argument may counter that it's not just holdings of Treasuries that are fanning inflation fears; it's the acquisition of massive amounts of other types of securities, such as agencies and MBS. However, this view doesn't appear to hold water either. Fed assets shot up when it started quantitative easing (QE) last September, but the size of the balance sheet is lower now and has been shrinking even as Treasury yields were moving higher.
-- Zubin Jelveh