Will the Fed Balance Sheet Get Spent into Circulation Causing Inflation?

Let’s take an artificial situation of the
Administration/Congress sending out another $1T in stimulus to consumers.  Assume also that this $1T has to be financed
by the issuance of Treasury debt as tax collections are already behind in
funding defense, entitlements and previous give-away–programs. 

There is a balance – the Treasury sends out the checks
which are paid for by largely bank and institutional (such as pension programs)
purchases of Treasury security debt.  Foreign and individual purchases have be negligible of late.)

One-fourth of this $1T received by consumers, according
to the most recent FRBNY study, is spent by on goods and services.  Thus $250B goes into GDP.   The
remaining three fourths is comprised by the one-third of the total going to
debt-payback and the remaining 5/12’s (42 percent) being saved.  Much of this three-fourths is bank-deposited
or used to purchase assets (real estate, equities, debt, etc.) the funds for which
can also wind up as bank deposits.

With much of this three-fourths winding up in bank hands,
no wonder that they’re complaining of a huge amount of money on hand.  Further, the banks have been reluctantly
slowing their loans as many people and companies have become overextended.  However the Fed in June raised the interest
rate it pays for bank reserves and also lifted the rate it pays on overnight
reverse repurchase agreements.

Switching over to the Federal Reserve Bank, the Fed has a
program to keep interest rates in check, especially at the short-term security
duration end, and thereby promote borrowing and economic growth. This program consists
of an ongoing monthly purchase of $80B in treasuries and $40B of GSE (Fannie
Mae, Freddie Mac, Sallie Mae, etc.) debt.  The treasury debt purchase portion has to be from the secondary market
as the law disallows Fed purchases directly from the Treasury Dept. (The Fed
does buy corporate debt, but this program is very small, or almost negligible
compared to what’s being addressed here.)

The $120B total is comprised by Fed newly created money.   Compared
to the value of new Treasury Dept. security issuance since the beginning of
this year, the Fed has bought some 43 percent in the secondary market, thereby
balancing a large part of the new issuance, primarily purchased by banks.

The $120B/mo purchases are added to the Fed’s asset balance
sheet.  It is the $120B/mo new money
creation that “waters the currency.”  This asset increase feeds into the supply of money, or M2 (although M3
and M4 are alternates.)  M2 has increased
$4.4T, or one-fourth, from 1Q19 to 1Q21.  However, nominal GDP increased only 1.4 percent during this period.  The increase in Fed assets was $3.5T or 80
percent of the nominal increase in M2.  Should we consider that the value of the dollar has also gone down 25
percent?

I cringe when I hear about inflation in that it only
addresses goods/services.  The inflation
of assets should be also included.  Look
at the dispensation of Government stimulus payments covered above.  The bulk goes to assets. GDP inflation is
only a subset of overall inflation.  Look
at your pet gripe about equivalent rental cost in CPI compared to the inflation
in residential housing prices.  Yet, it
is true that Government fiscal and monetary policy is directed to goods and
services.

A problem in determining future GDP or CPI goods/services
inflation, is how much spill-over from consumption of Government largesse will
occur?  Corporates (to support debt
payments, buybacks to increase earnings, and yields) and people on the dole
need more and more.  That’s the nature of
the beast and much of the cause of diminishing returns via the Government’s
actions.  When there’s not enough, there’s
a come-uppance.  Money will then flow
from equities/commodities/real estate to bonds.  This also will directly bear on the goods/service “real” economy. Then,
the Congress/Fed will act again to provide more – until the ultimate
reconciliation that this won’t work.

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