Following the financial crash, the world’s major central banks embarked on a dramatic experiment to stabilise the global economy and create conditions for recovery. Finding themselves out of conventional ammunition (interest rates quickly fell close to zero, but this was not enough to stem the bleeding), they began a series of ‘quantitative easing’ (QE) programs, historically unprecedented in size and scope.
In simple terms, this meant that the central banks committed to purchasing a set quantity of bonds and other financial instruments from private institutions, over a set period. The idea was to increase the money supply and improve liquidity so as to facilitate an expansion of private bank lending, buoying the wider economy. The Federal Reserve only stopped doing this last year. The ECB is still going.
Not everyone was happy with this plan. For many it sounded suspiciously equivalent to printing money. And the conventional economic wisdom on money printing is that it causes inflation. The idea makes sense: in an open market the value of an item is a function of its supply and demand. A drastic increase in supply without an attendant increase in demand will reduce the value of each individual item. This applies to money as much as anything else. If everyone in a market magically gets a free £10,000, the shopkeeper will simply raise his prices. He’ll have to, because his own suppliers will have raised their own prices, and his employees will demand higher wages. Unchecked, this process can create a runaway cycle termed hyperinflation.
This isn’t purely a hypothetical, we’ve seen it happen. The most famous case is Weimar Germany, where money printing created an environment in which the price of coffee would rise by the time you got to the front of the queue, and employees had to take their wages home in wheelbarrows. Given the sheer volume of asset purchases under the various QE programs, some sceptics – such as US financial analyst Peter Schiff – argued that it would inevitably trigger hyperinflation across the Western world.
There remains much debate and controversy over just how useful QE has been. But one thing is for certain: hyperinflation did not materialise. Not only that, but inflation rates across the Western world have stayed remarkably – even unhealthily – low. Far from hyperinflation, the real concern for authorities over the past few years has been deflation – hyper-inflation’s equally-nasty opposite.
So why didn’t QE cause hyper-inflation, or much inflation at all? This remains as open a question as the debate over whether and why QE was a good idea in the first place. Some note that not all increases to the money supply are inherently inflation-creating. If I print $1 trillion but then bury it in a hole in the ground, that will cause far less inflation that distributing it to consumers. This analogy perhaps isn’t that far removed from the reality of QE. By 2013 the Fed had expanded the monetary base from $0.87 to $2.92 trillion, yet it was still holding on to $1.62 trillion in excess private bank reserves – that’s $1.62 trillion essentially sitting in a hole, and not in circulation. Others point out that QE was launched during intensely deflationary conditions – that QE has had a substantial inflationary effect, but that this worked to offset deflation and avoid a crippling deflationary cycle.
And, of course, the prediction hasn’t completely failed yet – could it be that hyperinflation is still to come? That for some reason we’re seeing a lag between cause and effect?
What do you think? We’d be delighted to hear your thoughts in the comments section below. And of course these are precisely the sorts of economic questions we forecast on almanis. If you haven’t yet, register and get involved!