I’ve written about inflation several times because no other area of economic study is as relevant to us. Not knowing how much something is going to increase in cost, especially staples like electricity, water, and the 20 or so HD channels I already overpay for, creates ripples in our everyday lives and in the economy. Add to this the tendency of inflation to wipe out savings and retained value in assets (homes, equities) and you begin to understand how bad inflation really sucks.
However, I’m not as worried about inflation as I used to be. If you pay attention to the mainstream media, or better yet what’s left of it, you’ve most likely heard about all the ‘money’ the Federal Reserve has pumped into the ‘system’. I put ‘’ around money and system because it turns out that the Fed didn’t pump what can be considered money into what we vaguely refer to as the system. Despite the warnings from well known economists like Glenn Beck (he’s one of the reasons I call myself a libertarian and not a conservative) the way the Fed supported many of the ‘too big to fail’ financial train wrecks was not by giving them cash. Instead the Fed used a recently constructed and little known tool to essentially escrow the dough it gave to financial superfund sites like Fannie Mae and Freddie Mac.
The Fed didn’t print money and ship it in trucks to banks in the hope that they would lend it out. The Fed was able to keep its eyes on the liquidity it created by buying up mortgage-backed securities, bonds, and Treasury notes from financial institutions. It then made the banks park much of the proceeds (to the tune of about $1.1 trillion) with the Fed. It ‘incentivized’ these transactions by increasing the interest rate on excess reserves – the money the Fed pays the banks on the reserves the banks must keep with the Fed to protect their collective bottom lines.
Consider this the security deposit banks pay the Fed in order to use the Federal Reserve system to borrow and move money around. The banks will behave better with the Fed’s money if they can make more interest off of it and keep up their reserves so they don’t blow it all.
The banks and other financial institutions can take the money the Fed has provided but as the incentive grows, most banks will leave it be to ensure their balance sheets meet tougher standards. When the economy picks up, the Fed can adjust up this interest rate without significant impact to the economy due to the fact that the banks will be able to generate capital from ongoing operations. Eventually the Fed can either let this money flow back into the economy without contributing to inflation (as the economy expands and can soak it up) or it can pull it back in by raising interest rates.
So there, I feel better about inflation rearing its ugly head just as the economy recovers. And it’s good to know that there are creative and somewhat pragmatic people working at the Federal Reserve.
PS: I feel guilty for not being as entertaining as I usually am (I know you laugh at me not with me) so here’s something I hope can fill the gap:http://www.youtube.com/watch?v=d0nERTFo-Sk