Thursday, 23 April 2009

How Easy is Quantitative Easing?

A question for my macroeconomist friends:

It seems reasonable to expect that a central bank would increase the measured inflation rate (or at least the price index) by dropping freshly-printed money on an unwitting public from the proverbial helicopter. On the other hand, it would be unreasonable to expect that a central bank would create inflation by exchanging two freshly-printed ten-dollar bills for existing twenty dollar bills. What then should we expect for the inflation rate when a central bank exchanges newly-created reserves for government bonds, as is presently occurring in a number of countries engaged in quantitative easing, including the US and the UK? Is this more like the metaphorical helicopter drop or more like the exchange of ten-dollar bills for twenty-dollar bills?

And the ancillary question: Are there any examples of quantitative easing resulting in an increase in the inflation rate? There appear to be plenty of examples of governments generating inflation by using newly-created reserves to buy proverbial guns and butter. And there appear to be various examples in which interest rates have been lowered via open market operations, resulting in an increase in economic activity and eventually in the inflation rate. But I'm wondering whether we have any examples in which quantitative easing has resulted in an increase in inflation.

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