Does Quantitative Easing Cause Inflation?

Following the effects of the last financial crisis, as the nominal interest rate hit the zero lower bound, the central banks in United States, Euro Area and United Kingdom (to be more precise, it was the Bank of Japan that experienced this approach first) have started to implement a rather extreme form of unconventional monetary policy which became known as the Quantitative Easing.

But first, what is quantitative easing? A simple definition would be that is a policy that consists in large asset purchases of the central bank. What exactly does the central bank buy? Mostly government bonds, but also “high quality assets” (as Krugman mentioned, for the case of the FED, this means assets which already have a Federal guarantee). And a personal note: how sure can one be about the quality of an asset after the 2007-2009 financial crisis? Who evaluates them?

Everything would seem fine until now. This seems a new way to pump money into the economy and stimulate it. Moreover, many economists praise this strategy and think that it helped stabilizing the economy (though some other economists protest). Without entering into the multiple facets and issues raised by the quantitative easing, we are simply going to focus on inflation and ask whether this policy can lead to a growth in inflation.

It is well agreed that, by its very nature, the quantitative easing produces an increase in the asset prices. The Minneapolis Fed Chairman Kocherlakota acknowledged that the quantitative easing led to “inflation in asset prices”. However, the general public (and, unfortunately, some leading economists too) generally focuses on inflation understood as an increase in the consumer price index (namely CPI; even the FED considers a similar concept, namely the personal consumption expenditure index, PCE). But, as the current generally used measures of inflation would rather suggest that inflation remains low, proponents of quantitative easing would suggest that this kind of policy works well.

However, the main issue at hand is that the low measured inflation (based on CPI or PCE) is rather deceptive in seeing the effects of quantitative easing on prices. First of all, the growth of the asset prices is not at all accounted. Although a rise in the asset prices is not transmitted directly into consumer prices, we could expect in time that it will influence the consumer prices since more money will eventually enter into the economy. Furthermore, the firms will have more capital and can invest again in sectors like housing further raising the prices.

To sum up, when evaluating the effects of quantitative easing on inflation, we should take into account the limits of the consumer prices in expressing the various types of “inflation” in the economy (especially in assets) as well as the delays that might appears until the rise of consumer prices emerges. Not at last, it would be possible that the asset inflation created by FED will not be transmitted into consumer prices, but this will probably happen only at the cost of additional inflation in various assets.

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