The Federal Reserve, the Great Recession and the Lost Inflation

Abstract

Ever since the Federal Reserve began its series of Quantitative Easing, traditional monetary economists have been predicting levels of inflation that would rival the inflation of the late 1970’s and early 1980’s. The three QEs resulted in a more than quadrupling in the level of Federal Reserve assets in the fiscal years 2009-2015. During this seven-year period, Federal Reserve assets grew at an astounding annual rate of about 21%. Our usual pre-Great Recession theory of the money supply and prices would have suggested that a greater than 20% growth in Federal Reserve assets would result in at least double digit inflation. But none of our dire predictions about inflation happened. In fact, the two measures of inflation, the CPI and the GDP deflator, grew at surprisingly low rates of 1.2% and 1.4% respectively. The question is why did the predicted inflation not occur? There are at least two potential answers. One, everything we thought we knew about money and prices suddenly became irrelevant. Or, two, we were just ignoring things that made what has happened perfectly consistent with what we used to know.