Much attention is paid to the adjusted monetary base. It has risen from just over $800 billion in 2008 to over $3 trillion. So in less than 5 years, the monetary base has increased about $2.2 trillion. This started with the fall of 2008. It was called quantitative easing (QE). Then we went to QE2. Then we went to QE3. Then QE3 was expanded. Nobody is sure what to call it now. Regardless, it is major monetary inflation by the Federal Reserve.
Due to the high monetary inflation, many people expect much higher price inflation. While there is some debate about how accurate the CPI measure is, and while we have certainly seen some asset prices rise significantly (the stock market as one example), price inflation certainly has been contained when you compare it to the massive monetary inflation that has taken place.
One major reason is the demand for money. Due to fear in the economy, there is a higher demand for money. More people want to pay down debt and get a cushion with some extra money in the bank. The higher demand for money (lower velocity) means that money changes hands less frequently. This actually lowers prices, or in this case, offsets some of the monetary inflation.
Another factor in the somewhat subdued price inflation is the massive excess reserves. Banks typically lend out most of their deposits that are legally allowed. They are typically required to hold about 10% in reserve and the rest is lent out. You can see in the chart below that excess reserves were near zero most of the time before 2008.
But after the massive monetary inflation started in late 2008, the excess reserves held by banks went up almost in tandem with the monetary base. As seen on the chart, the excess reserves are now almost $1.8 trillion. So most of the new monetary inflation is being held on deposit by the banks. They have the Fed hold this money and they earn a measly .25% interest on it.
So while the Fed has created over $2 trillion out of thin air in the last 5 years, most of this has gone into excess reserves. The $2.2 trillion in new money is real and is available for people to use. But most of it is not being used by banks for fractional reserve lending. So it does not multiply through the system. This has kept a lid on price inflation.
I do not see anything differently with QE3 or whatever QE number we are on now. You can see that excess reserves have gone up by almost $400 billion since QE3 started.
We will continue to look at these two charts in tandem. It can’t tell us about the demand for money, but it can tell us about how much new money is in the system. As of right now, the money supply is increasing, but not nearly as fast as it could be if the banks decide to lend.