Via Paul Krugman's blog, "we are in a liquidity trap...and in such circumstances a rise in the monetary base does not lead to inflation." Krugman illustrates this with a couple of charts:
Japan, from 1997 through 2007:
And the United States in the 1930s:
As can be clearly seen from the above charts, a rise in the monetary base (i.e. the quantity of liquidity pumped into the economy by the efforts of the Federal Reserve) does not lead directly to increasing prices, as banks and other financial institutions are reluctant to lend (i.e. capital is hoarded). Why is this? We are up against the "zero bound" of monetary policy, where super low interest rates (approaching 0%) are effectively not low enough to entice banks to lend money to investors, since the risk of doing so outweighs the relatively cheap access to capital. Despite a nominal interest rate very close to 0%, the real interest rate may actually be several points higher, for instance if inflation is negative. Spending, particularly investment spending, turns negative, resulting in a contracted economy. What is needed when traditional monetary policy reaches its limits? Fiscal stimulus, with the goal of increasing aggregate demand and facilitating expectations of positive inflation.
And although we may or may not be stuck in a true liquidity trap currently, the present conditions are, nevertheless, not very conducive to inflationary pressures.
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