How the Fed May Delay the Onset of Inflation
Once the Fed massively increases the money supply, inflation is inevitable unless they can reduce the money supply before the inflation occurs. Without a significant economic recovery, however, removing money will cause a major crash, so instead of reversing the money printing, the Fed will likely take steps to try to slow the onset of high inflation. Here are four ways we think they will try to slow the onset of inflation:
1. Paying Interest on Excess Reserves
The Fed’s most powerful tool for delaying inflation is to pay interest on banks’ excess reserves. By law, all banks are required to keep a certain amount of funds in reserve so they can meet their customers’ needs for withdrawals. These reserve requirements prevent banks from lending out all of their money. Excess reserves are any reserves that banks keep beyond what is required. Normally, banks don’t keep any excess reserves for obvious reasons. Why would a bank want to keep excess reserves when it could lend out that money and make a profit on it?
The Fed, however, can encourage banks to keep excess reserves by paying banks interest on those excess reserves thus stopping banks from lending out this money.
Why would the Fed want to do that? They would do it in order to limit “the multiplier effect” that we mentioned earlier. The multiplier effect greatly increases the amount of inflation that comes from money printing because a relatively small amount of new money can create ...