Deflationary Decade? Fed Prepares Vacuum Cleaners

Are prices for consumer goods and services going into free fall over the next few years? Is deflation the likely scenario as record-level declines in commodity prices and government bond yields seem to suggest? Not if the Federal Reserve has anything to do with it.

The Fed has never increased bank reserves as much as it has in 2008. The previous high, was in 1934 when they rose by 57%. No doubt this stimulus played a role, says Northern Trust economist Paul Kasriel, in boosting real GDP growth from 1934 to 1937 by nearly 10% annually on average. The CPI increased in 1934, 1935, 1936 and 1937 by 3.5%, 2.6%, 1.0% and 3.7%, respectively. After the Fed began priming the pump, inflation did occur in the 1930s.

In 2008, the year-over-year increase in November 2008 in bank reserves was 600%, about ten times the previous all-time high in 1934. “The Fed’s seasonally-adjusted net acquisition of assets – primarily securities, commercial paper and loans to financial institutions – represented 100% of the seasonally-adjusted total borrowing by the U.S. non-financial sector in the third quarter of 2008,” writes Kasriel. In previous post-war recessions, this percentage rarely exceeded 20%. And more purchasing of government debt is likely to come when the Obama administration launches its massive stimulus package in early 2009.

There could be some price deflation in 2009 but if 1934 “is any guide, the Fed, starting in 2010, may have to invest in industrial size vacuum cleaners to start sucking up large quantities of credit that it had previously created!” Kasriel concludes.

Comments

[Moon Kil Woong:]

I agree after the bust if there is no boom then they will have a hard time dealing with the added primary money supply. I do however thing the de-leveraging will be long and protracted. Please realize I am not in a hyper-inflation camp for 2009.

Unfortunately, low interest rates on treasuries is liable to make the US government grow even more complacent. Since debt servicing costs are cheaper, they are probably going to feel safe to spend the US government into an even deep hole (if it's not already deep enough). So a large uptick in inflation will be a shockingly high percent of the budget when we do crawl out of our deflationary hidey holes.

2008 Dec 30 03:44 AM

[flow5:]

That's not the correct method of calculation. And that's not even the correct series. And even those figures are misleading, i.e., for the payment of interest on reserves. These IOR's do not function as excess reserves (or liquidity reserves), they are, if anything, equivalent to the "trading desk's" open market sales.

Excess reserves are now truely "sterile". They were never, previous to the IOR regime - sterile.

Economists get a grip.

2008 Dec 30 12:38 PM

[flow5:]

"previous high, was in 1934 when they rose by 57%"

During the Great Depression the FED added excess reserves but nothing happened. This is the origin of "pushing on string". It no connection to the volume of legal reserves today.

2008 Dec 30 01:11 PM

[flow5:]

"No doubt this stimulus played a role, says Northern Trust economist Paul Kasriel, in boosting real GDP growth from 1934 to 1937 by nearly 10% annually on average"

Net debt in 1939 was the same as it was in 1929.

2008 Dec 30 01:15 PM

[flow5:]

"represented 100% of the seasonally-adjusted total borrowing by the U.S. non-financial sector"

So what?

2008 Dec 30 01:17 PM

[sr9web:]

Since so much credit/debt has vanished with the popping of the credit bubble and since credit is a private source of money-inflation, the Fed has to replace that credit-money-inflation with more dollars.

2008 Dec 30 02:39 PM