28 September 2015

Yet Another Way That QE is Deflationary

Suppose the cash-credit model (here and here) of money demand is roughly correct, so when short term interest rates on safe assets (e.g. government bonds) are equal to the interest rate central banks pay on reserves, money demand is indeterminate. In this, case, increasing the money supply does nothing to the price level; monetary expansion just increases the real money supply.

Part of government revenue is seigniorage which can take the two forms: a.) inflation b.) real money growth. Since QE causes real money growth and not inflation, a lot of the seigniorage that would otherwise come in the form of extra inflation is already taken care of by extra real money.

Therefore QE is deflationary in a fiscal-theoretic way (this isn't even really FTPL, as actual fiscal policy doesn't matter). Q.E.D.

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