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non-bank QE and inflation revisited

Hi Cullen,

I have followup questions from these recent forum posts:

Post 1: Primary dealers act mostly as intermediaries for QE purchases by the Fed: https://www.pragcap.com/forum/topic/fed-purchase-of-bank-treasury-bonds-qe/

Post 2: Most of what the Fed bought is from non-banks, meaning money is injected directly rather than swapped and sits as reserve (which intuitively makes sense give Post 1): https://www.pragcap.com/forum/topic/qe-with-non-bank/

Post 3: Chance of higher inflation if we get back to normal soon: https://www.pragcap.com/forum/topic/which-risk-is-higher-now-deflation-inflation/

My questions are:

i) Doesn't  this mean that the Fed is effectively monetizing most of the new debt, instead of performing asset swap?

ii) I understand the immediate effect of QE is to force lower interest rate when it is already close to zero. However, when recovery starts, with several trillion new money this time around compared to Great Financial Crisis, wouldn't the expected inflation be much higher now with direct injection vs  asset swap?  Will the Fed be able to unwind fast enough to prevent much higher inflation?



1) Sure, if you want to say they're taking one money-like instrument (a T-Bill) and making it marginally more liquid (deposits) then yes, they're monetizing. Personally, I think the distinction overstates the difference between a T-Bill and deposits. They're not that different. It's like having a checking account and a savings account.

2) I think you've gotta separate fiscal policy from monetary policy. Fiscal policy is where the new net financial assets are created when the govt creates the bond. QE just changes the composition of those financial assets. So, in the current environment it's the fiscal policy that is the big bazooka and if the economy reopens quickly then yes, it's easy to put together a scenario where inflation shoots right back to where it was pre-crisis or higher because there's a lot more safe assets in the economy that are chasing a similar (or lower) quantity of goods.

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche

Hi @cullen-roche,

Thanks for the reply. A couple of follow-up questions:

1) Is the issuance of several trillions in new treasury bonds, with more to come,  even possible without QE driving down the interest rate? Is there a way to model what the interest rate for the new bonds would be without QE?

2) Is there a way to model how much the new treasury bonds will contribute to future  inflation?


Impossible to know to be honest. Interest rates have traditionally sold at a slight premium to inflation. So it makes sense that long rates might trade at 1.5-3% without QE. But that also assumes inflation will jump from its current levels since the treasury market is currently pricing in very very low inflation.

I don't think anyone knows how inflationary govt debt is. There are just too many other variables that impact it. It's kind of like trying to figure out whether a product will be profitable. Who knows?

One thing we do know is that govt debt in the USA hasn't been inflationary thus far. My theory is that there are other more important factors that offset the degree to which govt debt is inflationary. This includes demographics, tech trends, the dollar as reserve currency, etc. So, in order to find a high inflationary theory you have to assume these big trends will change meaningfully.

Modelling all of this is clearly hard, if not impossible....

"Pragmatic Capitalism is the best website on the Internet. Just trust me. Please?" - Cullen Roche