The phantom inflation menace, and a credit crunch update

Krugman has it right here, in yesterday’s NYT. I’d been planning a post on the recent spate of fear-mongering about the deficit, and Krugman covers a lot of the same ground.  One of the arguments against deficits is that they may lead to high inflation down the road, if the government leans on the central bank to “inflate away the debt” (i.e., jack up the price level so as to reduce the real burden of the national debt), but Krugman notes that there are precious few such examples in recent (post-WWII) history.  He concludes:

‘. . . it’s hard to escape the sense that the current inflation fear-mongering is partly political, coming largely from economists who had no problem with deficits caused by tax cuts but suddenly became fiscal scolds when the government started spending money to rescue the economy. And their goal seems to be to bully the Obama administration into abandoning those rescue efforts.

‘Needless to say, the president should not let himself be bullied. The economy is still in deep trouble and needs continuing help.

‘Yes, we have a long-run budget problem, and we need to start laying the groundwork for a long-run solution. But when it comes to inflation, the only thing we have to fear is inflation fear itself.’

Krugman also debunks the notion that “the Federal Reserve is printing lots of money.”  The Fed has of course been very active in trying to stimulate the economy through expansionary monetary policy, which involves crediting banks with extra reserves.   But this isn’t the same thing as printing money!  The closest the Fed comes to printing money is when it buys government bonds directly from the government, which it generally does not do.  Lately, the Fed has seen to it that banks are flush with excess reserves (currently at $877 billion, up from just $2 billion a year ago), apparently to stave off liquidity problems and so that they might make more loans to consumers and businesses.   New loans, when spent and redeposited into the banking system, would increase the money supply, but that hasn’t happened to a great degree.

A check of the recent monetary arithmetic bears Krugman out.  Despite the huge volume of excess reserves, the money supply increased at an annualized rate of just 2.6% (using the standard measure, M2) or 4.1% (using the narrower measure, M1) in the three months from January to April 2009.  The April-to-April (2008-2009) increases are much larger (8.5% for M2, 15.9% for M1), but nearly all of those increases occurred in August to December 2008, as the financial crisis was ragin’, full-on.

Why did the money supply increase so much ($451 billion increase in M2) in those four months?  Some of it may have been redeposits of loans, but probably not much, as the total increase in bank loans was only $267 billion, (or less than 4%), and normally only a fraction of money loaned out gets redeposited into the banks.  The rest looks more like portfolio reallocations away from stocks and corporate bonds into super-safe liquid assets like cash (up 12%), checking accounts (“demand deposits” up 37%), and small CD’s (up 19%).

CREDIT CRUNCH UPDATE:  I suppose it’s noteworthy that the volume of bank loans increased at all during that time, when the financial crisis was at its apex and a “credit crunch” seemed to be devouring the economy.  The word of late has been that the credit crunch has eased considerably, as evidenced, for example, by low interest rates on interbank loans (the “Libor”).  What do the Fed’s weekly and monthly figures on bank assets tell us about recent credit conditions?  They don’t look too pretty.  The total volume of bank loans (“Loans and leases in bank credit”) has been falling slowly but steadily every month since October 2008 and is now 2% less than it was then, at the height of the crisis.   The volume of commercial and industrial loans has also fallen steadily and is now 6% less than in October.  Real estate loans and consumer loans are up slightly, but only by about 1%.  Probably the biggest credit crunch was in interbank lending, which fell about $100 billion or 22% from October to November and then regained that amount by January.  (Interbank lending has been steady at about $450 billion all year.)

So whither the credit crunch?  It may well be over, or on its way out.  The bigger problem right now seem to be that many consumers and business don’t want to borrow, because they are not confident in the future.  In addition, with 5.7 million new unemployed since the recession began a year and a half ago, and many self-employed facing reduced demand for their products, there probably are a lot fewer households that could qualify for a bank loan today, even without any tightening of standards.   So the seeming end of the credit crunch is better than nothing, but cold comfort to millions of Americans.


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