Keynes suggested that a situation could emerge where the lowering of the interest rates by the Federal Reserve could bring rates to a level where they could not fall any further, people may then be concerned that the rates will inevitably rise and refuse to borrow the money that the banks have ready to lend no matter how low the interest rates are. Past a certain point, an increase in the money supply will have no stimulatory effect on the economy. His solution to this problem is not only incorrect, but irrelevent to my question so I won't bother going forward.
Anyway, I would argue that we are currently in such a situtation that Keynes talks about. My question is, even though the federal reserve has announced QE3, will QE3 have any effect on inflation if the banks do not lend it and the money is never spent? Since it will never be spent, there will not be an increased supply of money in circulation chasing the same amount of goods. The ripple effect will not take place. Has inflation become stagnant?
The QE or money creation is the inflation, rising prices is one of many symptoms and not the worst. The worst effect is the "Crackup Boom" when consumers just buy anything to get rid of cash. We have reports from South American countries where people had fist fights over purchasing tubes of toothpaste and other essential items. In this situation prices jump but economic activity jumps as well signalling the central bank that they are actually stimulating the economy when they have in fact created a panic. The other effect whose severity is between rising prices and the crack up is the malinvestment of scarce resources that can not be regained and cause misery in terms of lost opportunity.
Inflation is not stagnant. It is eating away at the economy all the time. See shadowstats.org for the real inflation rate. But even this may seem modest until it isn't. The hardest part of all of this is the timing. The economy is super complex and in the short term anything can happen, but the long term can creap up on an entire economy. Look at Spain their short term bond yields went from 1.5% to over 5% back down to 3%. So the yields have doubled in less than 1 year.
But doesn't inflation only take effect after the money is 'spent' and suddenly there is a larger supply of money chasing the same amount of goods? If the money is created and not spent, what exactly causes prices to go up? Is it the simple fact that people know that there is more money sitting in some account somewhere?
But doesn't inflation only take effect after the money is 'spent' and suddenly there is a larger supply of money chasing the same amount of goods?
If you are talking about price inflation, yes.
If the money is created and not spent, what exactly causes prices to go up?
Nothing.
Is it the simple fact that people know that there is more money sitting in some account somewhere?
How many people know that?
As for your OP, a few comments.
1. The govt must be getting some of that newly printed money, because Bernanke is buying treasuries with it, directly or indirectly doesn't matter. The banks themselves reloan that newly printed money right back to the Fed to get some interest payment. What the Fed does with its money is off the books, as is well known. The point is, plenty of that money is getting spent by the govt, thus raising prices. I mean, we have trillion dollar deficits, meaning huge amounts being spent that is not collected in taxes. Where is that money coming from?
My point is that there is very good reasn for the current price inflation. That it is not even worse is for the well known reason that a lot of dollars get sent abroad, never to come back, because they are used in international trade as the worlds reserve currency.
2. It's not that nobody wants to borrow from the banks because they expect deflation, as Keynes feared, but that the banks are terrified of lending it to anyone but the govt, lest they not get repaid. For every dollar they have stashed away, they owe three. Thus they are prudently keeping some backup in cash and not lending it. Of course lending it to the govt is not a risk at all, because the govt never defaults.
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I guess my confusion is that if QE3 can't get banks to lend anymore than they would have before QE3, exactly where and how does monetary inflation take place? If the fed printed 40 billion a month and gave it to me, but I continuously buried it in the rainforest somewhere, why would that effect the value of money if it never ends up in circulation?
Or does monetary inflation not necessarily have any visible effect on the economy until it is lent/spent, resulting in price inflation?
I have a question as well. If QE 3 works as intended then how can we not suffer significant price inflation? Cleary Bernanke is more focused on employment than he is on inflation so if we assume QE 3 causes unemployment to drop to say 5%, by the time that happens wouldn't there have been significant amounts of money in circulation during that time period causing price inflation?
Some people seem to believe that QE 3 will work, that is, that QE 3 will spur lending and employment but I just don't see how that can happen without significant price inflation.
People that believe that QE3 would work are flat out wrong, whether the money gets lent out into circulation or not.
In your proposed situation, QE3 would cause significant inflation. If the money the banks receive DOES get lent out and spent, there will be a much higher surplus of money chasing a fixed amount of goods. Prices must go up. In my scenario, the money gets lent to the banks but never spent.
I guess my confusion is that if QE3 can't get banks to lend anymore than they would have before QE3, exactly where and how does monetary inflation take place?
I finally got it. For some reason, in my mind, I kept trying to see monetary inflation. But now I understand that the newly created money is monetary inflation itself, but doesn't necessarily effect the economy until it is spent. I was looking for the initial effect it has, which there is none, of course, until it is spent. Price inflation will then slowly become apparent, but only as a result of the initial inflation caused by the monetary expansion.
Price inflation can happen, it doesn't necessarily mean it will happen. Everything is based on all else being equal and predicated on the idea that the inflation measures will be able to catch the price rise if it does occur. Everything else doesn't remain equal, and the inflation metrics may or may not catch the price rise if it happens.