Macro Economy

Will the Fed's Quantitative Easing Lead to High Inflation?

来源: CHINA FOREX 2020 Issue 3 作者:Yang Zirong
High M2 growth rate will not necessarily lead to high inflation,as the...

Unprecedented stimulus policies have been taken by the United States in response to the Covid-19 pandemic and these have led to a dramatic expansion of the Federal Reserve's balance sheet and the fiscal deficit. One big concern is whether these measures and the restarting of the economy will lead to high inflation. Since the financial crisis in 2008four rounds of Quantitative Easing (QE) have been initiated by the Federal Reservewithout creating much higher M2 growth rate or high inflation. But the unlimited QE policy initiated by the Federal Reserve this time has pushed the year-on-year M2 growth rate to a new historic high. Why is it different this time? Will high M2 growth result in high inflation? Will there be other factors that contribute to high inflation in the future?

Causes of High M2 Growth

Base currency refers to the total cash held by the public and  circulating outside the banking system as well as the reserves held by the central bank against deposits in the commercial banking system. It is also called high-powered moneysince it has the capacity to enlarge or shrink total currency substantially. It is provided by the central bank and released when the central bank's balance sheet is expanded. Through the money multiplierbase currency can be expanded to broad money (M2)so the enlargement capacity of base currency is determined by the money multiplier.

Since the 2008 financial crisisthe Federal Reserve has launched  four rounds of QEenlarging the Fed's balance sheet by 4.6 times from US$0.97 trillion in September 2008 to US$4.46 trillion at the end of 2014. Howeverover the same period the average year-on-year CPI growth was only 1.65%showing no high inflation from this unlimited QE. To cope with the economic shock of Covid-19the Federal Reserve's balance sheet was expanded once more in 2020with the total of assets and liabilities increasing from US$4.13 trillion in February to US$7.09 trillion in June. Neverthelessunlike in 2008the year-on-year M2 growth rate during this period of QE reached a record new high in May at 23.14%the highest level since 1960. In comparisonthe highest year-on-year M2 growth rate was only about 10% during the QE of 2008. Why was it different this time?

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