Saturday, April 23, 2011

The flow of funds

So the question is, given recent actions by the Federal Reserve, are we facing any risk of inflation right now? The definitive answer to this question is in the flow of funds data released by the Federal Reserve on a quarterly basis. So let's look at what's happening...

So let's start on Page 1 of this report, the overall summary. What it shows is, starting in 2008, a massive increase in the Federal debt... but a massive increase more than offset by an equally massive *decrease* in consumer borrowing. In short, if we're talking about debt as the engine of money creation as is popular with the MMT crowd, less money is being created today than was the case in the period 2001-2007.

Okay, so we can get that striking conclusion from page 1 without going further, but let's go further. One principle of economics is that money which is under a mattress somewhere essentially ceases to exist as far as the economy is concerned. The banking system has the world's biggest mattress. If there's more money flowing out of banks into the economy, we may face inflation. If there's more money flowing into banks than out of them, we have a problem with monetary deflation (which, remember, may not be the same as price deflation due to the issues of wage stickiness and price stickiness, which tend to result in production decreases a.k.a. layoffs, hours reductions, and factory closings rather than price decreases when a mild to moderate amount of monetary deflation occurs). So let's look at total loans by commercial banking on a flow of funds basis, table F.215 on page 48, which shows that bank lending last quarter grew by... -340.1 billion dollars. Indeed, looking at mortgages, consumer credit, everything in that table, it looks like we're on the precipice of a massive *deflationary* event. Well, except for the fact that the U.S. government's massive borrowing largely offset this massive decline in bank lending. Indeed, banks are no longer increasing the amount they have on reserve at the Federal Reserve, instead the data shows they're buying Treasuries instead.

So the conclusions I can draw from the flow of funds data regarding the possibility of inflation are:

  1. The economy still sucks, and it sucked more in 2010 than people are willing to admit. If the economy didn't suck, banks would be lending, not contracting their lending.
  2. We are at the precipice of a massive deflationary event. The only thing preventing that right now is massive borrowing and spending by the Federal government. Take that prop away, and we're in Great Depression 2.0.
  3. People harping on about inflation are full of shit. This money they claim is being printed willy-nilly, the flow of funds data shows is ending up un-printed as the monetary multiplier continues its free fall to unity as bank lending continues its precipitous decline. The asset price bubbles we're seeing today are the same ones we saw *before* the Great Recession, and are a result of tax policy that encourages asset bubbles, not inflation.
There's lots more that can be said from the flow of funds data, but I'm still a bit tired, so I'll let others do that...

-- Badtux the Economics Penguin

1 comment:

  1. Wait . . . tax policy influences the economy?!?

    Sorry, couldn't resist.

    By the way, the only multiplier I know is for M1, and it's been below unity for 2 1/2 years!



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