Why isn’t inflation higher?

The Federal Reserve created trillions of dollars of new money in an effort to fight the recession. For a long time, economists have said higher inflation can result when large amounts of new money is printed. But inflation today is still relatively low. Why? NC State University economist Mike Walden explains.

“And indeed if you look at both government and private sectors in terms of inflation, we are hovering around 2 percent. And the Fed has printed a lot of money — and that’s one of the powers they have; they can create money out of thin air. So it’s a very relevant question.

“And the answer hinges on what the Federal Reserve did differently this time as in the past. What the Federal Reserve does when they print money (is) they go to banks; they buy investments from banks. They pay for those investments with this newly printed money. The banks can then take this newly printed money, loan it out, that gets in the system, and if that gets in the system at a very rapid rate, that can result in higher inflation.

“Here’s what the federal reserve did differently this time. They printed the money. They went to the banks. They bought investments from the banks. But then they said to the banks, ‘You know what, banks? If you will put that money that we have provided you back into the Federal Reserve, we are going to pay you interest on that. And it’s going to be a low risk interest rate.’ And the banks said, ‘Hey, this is too good a deal to pass up.’ So the banks did that.

“So effectively the money the federal reserve created is still sitting back with the Federal Reserve, and that’s the reason we still have very, very low inflation. Some say there’s a downside to this in the sense that that printed money did not get out on the street in the form of loans. It’s still hard for most people to get loans. Some argue that the Federal Reserve has traded off low inflation for a slower-growing economy.”

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