Unprecedented times call for unprecedented measures, but newly imposed measures of fiscal and monetary policy have reignited old fears of hyperinflation and debt. With the sheer importance and complexity of monetary policy rarely mentioned in political discourse, common misconceptions frequently arise. The most common one being that creating money always causes inflation.
But before a conversation surrounding inflation can begin, it is important to understand the basics of monetary policy and who controls it.
Although it varies by country, most governments have a national central bank that possesses the power to enact various economic policies without the approval of Congress or parliament. In the United States, the central bank is known as The Federal Reserve (simply known as the Fed) and is led by a Board of Governors consisting of seven members who are appointed by the president and serve staggered 14-year terms. This board is responsible for using many of the Fed’s various, complicated tools to direct a nation’s economy. However, since this discussion is about inflation, it is critical to understand what is arguably the most essential tool of monetary policy: Open market operations.
In short, open market operations are simply the buying and selling of government-issued securities (loans to the government) by the central bank, which is used to increase or decrease the amount of money circling around in an economy. There are three main government-issued securities that vary by interest rates and the time they take to mature: Treasury bills, notes, and bonds. Treasury bills are short-term investments that are usually redeemed in less than a year with lower interest rates while treasury notes and bonds are longer, multi-year investments that yield higher interest.
So where does the Fed come in?
Treasury securities can be bought by the Fed from big banks and businesses in order to inject money back into the economy when it is desperately needed, typically during a recession. But the Fed does not buy these securities as an ordinary investor would with cash, instead they simply create money by depositing it into the digital bank accounts of their sellers with a single keystroke in a process known as quantitative easing.
Not necessarily. The reason the Fed is able to do this without immediately causing hyperinflation is because such extreme measures are only taken during serious financial crises that create “very prominent deflationary environment[s]” (when prices fall) known to cause devastating economic stagnation. Such extraordinary crises rarely occur, but during the Great Recession in 2008, the Fed created trillions of dollars to counter the extreme deflation during the crisis and is now enacting similar policies to control the financial fallout that has followed the coronavirus pandemic.
Despite the prior successes of quantitative easing, some still fear that such money creation will lead to inflation, such as former Texas congressman Ron Paul, author of “End the Fed”, and many others who identify as libertarians. However, “high inflation did not materialize in 2008 and an arguably bigger concern – then and now – has been persistently low inflation, which eventually could lead to deflation or falling prices, that prompt consumers to put off spending and hurt the economy”.
Unfortunately, there is still a lot of confusion surrounding the driving forces behind inflation, as many unfounded accusations about how increases in public spending for social programs or universal basic income would cause inflation have occasionally made their way into the mainstream. Ironically, many of these programs would be funded through taxation, which is often used to counter inflation, not cause it.
The truth is that any country that horribly mismanages its macroeconomic policy will cause hyperinflation, regardless of their political ideology. If a country’s leaders suddenly decide to create large amounts of its currency without proper planning, hyperinflation will certainly follow. However, this should not be confused, as it so often is, with effective, stabilizing monetary policy that saves countries from further economic disaster.