Quantitative Easing and Its Effect on Inflation

Quantitative Easing and its Effects on Inflation

Alex Boogren

Tarleton State University

8/5/2013

Quantitative Easing and its Effect on Inflation

Quantitative easing is a type of monetary policy used by central banks to help stimulate the economy by increasing the monetary base. Since the housing market collapse and the recession that followed, the United States has implemented this policy by purchasing financial assets, primarily mortgage backed securities, from commercial banks and other financial institutions (Folpmers, 2010). The Federal Reserve has done this in three consecutive rounds termed QE1, QE2, and QE3, with the most recent beginning in September of 2012. Historically, this type of enormous increase in the money supply has led to severe inflation, which was observed in Germany during the 1930's and more recently in Zimbabwe. With that said, why hasn't the United States experienced the type of inflation seen in those countries? In fact, inflation has actually decreased since the Federal Reserve began quantitative easing, albeit only slightly (Yue & Leung, 2011). This paper will attempt to explain this phenomenon as well as what could cause major inflation or hyperinflation in the future. Then, we will examine the risks the United States faces if inflation does take off given the current political climate in Washington.

So, what is causing the United States' inflation rate to be stable while there is a huge increase in the money supply? According to the study done by Yue and Leung, inflation has not increased significantly during quantitative easing because most of the money is not making its way into the real economy (2011). Typically, increases in the money supply lead to more lending; however, since the recession, commercial banks have steadily decreased the amount of money being lent out, therefore preventing this newly created money to reach consumers and businesses alike. As the money is not being circulated through the economy, it makes sense that inflation isn't rising wildly. Banks are still rebuilding from the crisis and just simply are not able to lend at the levels they were pre-crisis. Another reason inflation has been tamed even during quantitative easing is that the fact that we are in a recession. Although there is a larger supply of money, businesses do not need it right now. Instead of expanding and making use of the extra cash available, most companies are shrinking due to decreased consumer demand (Stiglitz 2012). Finally, the housing market crash left many Americans in debt, so we have a large number of people trying pay down their balances rather than seeking more credit. When you put this all together, it is easy to see that the increased supply of