Quantitative easing, or the practice of the central bank printing money during the bursting of debt bubbles, comes in for a lot of criticism. Usually the two kinds of criticism that it comes in for are that (1) it creates inflation, and (2) that it won't succeed in lowering yields.
This week, two separate reports seem to be refuting these criticisms. First, Labor Department reported Friday that its Consumer Price Index was unchanged from June on a seasonally adjusted basis, and that prices this summer were 2.1 percent lower than last July. This is the lowest inflation since 1950, despite a bond buying program of over $1 trillion and $300 billion in purchases of US Treasuries by the Fed over the past several months.
Where is the inflation, quantitative easing critics?
Secondly, in one of the first independent analyses of quantitative easing, the IMF reported that
Long-term UK government bond yields appear to have been suppressed by about 40 to 100 basis points by the Bank of England as a result of its unorthodox monetary policies, an International Monetary Fund study has calculated.
and
Analysts said this large bond intervention was a key factor behind why the UK has managed to keep 10-year gilt yields below 4 per cent in the past three months, even as the UK debt and issuance has spiralled.
but despite this,
But in the second quarter of this year, this measure of the money supply grew by just 3.7 per cent, barely faster than the 3.3 per cent in the first quarter, and much slower than the average growth of around 8 per cent before the financial crisis.
In other words, the Bank of England's purchases of UK debt has succeeded in lowering yields on their bonds, gilts, compared to where they would be without those purchases. But the money supply is still growing much more slowly than it was during the boom.
Why Doesn't Monetization cause Inflation?
The reason is that "money" in the modern economy is not just the notes that the government prints. That is only M0-- the monetary base. The actual "money supply" includes private money created by private banks and financial institutions that use leverage. These include bank deposits, money market accounts, bonds, and derivatives. These are not official money, but they act as money in the economy, influencing price levels. It was this private money as well as Greenspan's that caused the massive run-up in real estate prices in 2000-2006.
But when the bubble bursts, this money is destroyed; the effect is a contraction of credit generally through the economy; the money supply contracts as the money multiplier collapses. This is deflationary. The central bank's printing money does not actually expand the money supply, it merely prevents the money supply from collapsing.
The fact is that we have to print money. Every asset bubble burst has ended with the liquidation of the debt in some way, shape or form: it is paid off over time, through outright default, or it is monetized. Trying to rely solely on default or paying off debt will only cause the economy to sink further into a depression. For America to reduce its debt without crippling deflation, all three of these measures will have to be undertaken.