Swedroe: Easy Monetary Policy = Inflation?

August 11, 2014

Why Hasn’t Inflation Been A Problem?

One reason we haven’t seen rampant inflation is that, over the six-year period from July 21, 2008, through July 21, 2014, the growth rate of M2—a broad measure of the money supply—hasn’t been increasing at a pace that would indicate the likelihood of widespread inflation. The rate of increase has been 6.75 percent per year, with M2 growing from $7,728 billion to $11,439 billion over the period.

While loose monetary policy—along with our massive budget deficits—does create the risk of (or potential for) rising inflation, it certainly isn’t a guarantee that rising inflation will occur.

There certainly is risk that inflation could increase dramatically. The reason it hasn’t yet is that, while the monetary base has been increasing rapidly as the Fed expands its balance sheet through its bond buying program, the velocity of money has been falling sharply, from 2.0 at the end of 2007 to 1.5 at the end of the second quarter of 2014.

If velocity were to increase, the Fed would have to undo its bond buying program to shrink the monetary base and prevent inflation from becoming a problem. And that could put pressure on interest rates. Of course, the Fed is well aware of this necessity.

If you need further evidence that easy monetary policy doesn’t necessarily lead to inflation problems, you only have to look to Japan. Despite easy monetary policy and massive budget deficits, Japan’s biggest problem has been deflation, not inflation.

Keep this in mind the next time you’re tempted to listen to some guru’s forecast about rising interest rates. The historical evidence is clear that the winning strategy in both stocks and bonds is to ignore all forecasts and stick to a well-developed plan.


Larry Swedroe is the director of research for the BAM Alliance, a community of more than 130 independent registered investment advisors throughout the country.


 

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