American in Paris

Forex Markets: A Look into the Dollar Part IV

Not a very impressive analysis. Indeed, I struck by how these two authors worry about inflation in the midst of a severe global recession. The very same reaction we seen during the early stages of the Great Depression - financial analysts worry about inflation as the economcy tanked and deflation became the norm.

Inflation requires sustained increases in the money supply, but the Fed stopped targeting monetary aggregates because financial deregulation undermined any clear cut relationship between the various money supply figures and GDP and the price level. Really no one knows the economically relevant definition of money any more.

Indeed, the Fed does not directly control the money. Instead, it injects and withdraws reserves from the banking system and reserves are not money (money is a medium of exchange in the hands of the public).

Neither M1 nor M2 are growing rapidly because the Fed's injections of funds are being offset by a weaker money multiplier ratio.

In other words, the banks are not lending these additional reserves and hence excess reserves are skyrocketing.

No inflation on the horizon.

Inflation should not be the focus.