I just want to make a simple, but important, point about money and credit that is being overlooked by just about everybody except David Malpass. That’s true of a lot of things, by they way.
When a commercial bank makes loans or purchases government securities, both sides of its balance sheet are affected. On the asset side, either loans or investments rise. We usually call that combination “credit.” At the same time, on the liability side of the balance sheet, deposits rise by an equal amount. Those deposits are usually considered part of the money supply. When the deposits are spent, they will end up on other banks' balance sheets, but will remain somewhere in the banking system.
Economists are aware of the credit counterparts of deposit money, but they usually focus on the money side of the equation. Is too much money being created? Too little?
Normally, focusing on the liabilities or money side of bank balance sheets is fine. Credit is following along. They move together. However, credit is also created outside the commercial banking system when the counterpart is not counted as part of the money supply. As long as the relationship between money and credit remains pretty much unchanged, watching money only creates no problem.
However, during the financial crisis over the past year, credit created outside the banking system—commercial paper, for example—has shrunk. The Fed has tried to counter that shrinkage by buying commercial paper directly, but credit has still shrunk. I repeat: credit has shrunk; not only bank credit that has a counterpart in the money measures, but non-bank credit as well.
My point is that, when people talk about excess money creation, they usually forget that part of the money creation is necessary to offset the impact of the credit contraction. Money expansion is also necessary to counter the decline in the velocity of money. Both reasons are important in understanding that money creation so far has not been inflationary.