Tags: Meltzer | Fed | inflation | reserves

Meltzer: US Can't Avoid Inflation

By    |   Tuesday, 11 June 2013 07:52 AM

The U.S. economy has escaped inflation despite the Federal Reserve's massive liquidity infusion ... so far.

The inflation-free economy won't last forever, warns Allan Meltzer, a professor of political economy at Carnegie Mellon University, in an article for Project Syndicate.

The Fed has created enormous amounts money by purchasing bonds from banks in its quantitative easing (QE) program.

Editor's Note:
Economist Warns: 50% Unemployment, 100% Inflation Possible

Yet inflation is remained low, at about 2 percent, because banks are keeping the additional liquidity as excess reserves rather than lending it out, Meltzer contends, which not only holds down inflation, but also holds down job growth. That explains why the recovery has remained so slow and unemployment has stayed high, he notes.

In response, instead of changing its tactics, the Fed launched more QE.

Yet as in the earlier QE rounds, the bulk of the additional liquidity remained idle in bank excess reserves.

"While subdued liquidity and credit growth are delaying the inflationary impact of the Fed’s determination to expand banks’ already-massive reserves, America cannot escape inflation forever," Meltzer writes. "The reserves that the Fed — and almost all other major central banks — are building will eventually be used."

Because banks earn 0.25 percent interest on excess reserve accounts and pay interest rates near zero to their depositors, they chose to earn risk-free interest rather than circulate it into the economy, Meltzer says. Banks may lend to the government and large stable corporations, but not to riskier borrowers like start-up companies or first-time homebuyers.

"While speculators and bankers profit from the decline in interest rates that accompanies the Fed's asset purchases," he writes, "the intended monetary and credit stimulus is absent."

The problem is not lack of liquidity but insufficient investment, Meltzer argues. He blames the increase in taxes on incomes over $250,000, President's Obama's proposal to cap retirement entitlements and uncertainty over new regulations for hurting investment. Plus, healthcare reform has hampered employment growth because businesses are reducing hiring and cutting hours over fears of higher labor costs.

Sen. Bernie Sanders, I-Vt., has said he is working on legislation that would prohibit banks from receiving interest on their excess reserves in order to prompt banks to circulate the money into the economy, notes Forbes contributor Bob McTeer.

However, as Fed Chairman Ben Bernanke explained, while individual banks might reduce their reserves, the banking system cannot, McTeer writes. Banks reducing their reserves for security purchases will only prompt banks selling the assets to increase their own reserves.

Editor's Note: Economist Warns: 50% Unemployment, 100% Inflation Possible

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The U.S. economy has escaped inflation despite the Federal Reserve's massive liquidity infusion ... so far.
Tuesday, 11 June 2013 07:52 AM
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