Dirk McCoy

The Race to Zero Interest Rates

Kathy,

How did quantitative easing create deflation in Japan? Conventional wisdom is that increasing the money supply will creat inflation as more money chases a limited amount of goods and services and prices rise.

Coining money is actually one of the enumerated powers of our Federal government. When technology and trade create additional capacity for goods and services, relative prices must change. If money is constrained so that inflation becomes impossible, then deflation occurs. Debtors have a harder time making payments, and the wealthy start to hoard cash instead of spend or (risk) invest it. Velocity of money drops, and using the old formula MV=QP, economic activity (Q) has no choice but to drop.

As we live in a country where democratic value (in theory) is placed on ideas and labor moreso than wealth, it shouldn't be a surprise that government and its central bank at some point will be forced to increase the money supply. And given the enormous increases in technology (an entire new cyberspace universe to monetize) and trade (a billion new workers available to global trade), it should be obvious that the supply of money should have been increasing at an unprecidented rate. That it didn't- and that elaborate credit schemes emerged in its place- shouldn't be a shock. And that the stock of money will now increase on a massive global scale shouldn't be all that surprising- or worrisome- either.