History May (Or May Not Be) Your Guide

Economist James Hamilton reminds that we should recognize a distinction between claims that the Fed is printing money proper and crediting accounts at banks that are part of the Federal Reserve system. “These electronic credits, or reserve balances, are what has exploded since 2008,” Hamilton notes. Currency in circulation, by contrast, “has increased by 5.2% per year over the last two years, a bit below the average for the last decade.”

Hamilton goes on to explain:

If you took a very simple-minded monetarist view of inflation (inflation = money growth minus real output growth), and expected (as many observers do) better than 3% real GDP growth for the next two years, you’d conclude that recent money growth rates are consistent with extremely low rates of inflation.

The great uncertainty, then, is how the Fed unwinds this electronic credit creation. Again quoting Hamilton:

As business conditions pick up, the Fed is going to have to do two things. First, the Fed will have to sell off some of the assets it has acquired with those reserves. The purchaser of the asset will pay the Fed by sending instructions to debit its account with the Fed, causing the reserves to disappear with the same kind of keystroke that brought them into existence in the first place. Second, the Fed will have to raise the interest rate it pays on reserves to give banks an incentive to hold funds on account with the Fed overnight.

Doing this obviously involves some potentially tricky details. The Fed will have to begin this contraction at a time when the unemployment rate is still very high. And the volumes involved and lack of experience with this situation suggest great caution is called for in timing and operational details. Sober observers can and do worry about how well the Fed will be able to pull this off.

But that worry is very different from the popular impression by some that hyperinflation is just around the corner as a necessary consequence of all the money that the Fed has supposedly printed.

Tricky isn’t necessarily fate. Yes, central banks make mistakes, but they do get things right at times too. That includes some success stories with exit strategies. No guarantees, of course. The future’s always unclear, even in the best of times. Assuming the worst, however, requires more than casual references to history.