I originally posted a version of this as a comment to this blog post:
Why is the Fed doing this? on Econbrowser.com
I wouldn't worry too much about QE2. I don't think the Fed could cause inflation right now with any reasonable amount of QE. Here is my reasoning.
1. In an economy that is 70% consumer spending inflation cannot get very far without corresponding increases in nominal household income. If prices rise without corresponding increases in household income aggregate real demand will fall in proportion to price increases and quickly snuff inflation.
2. Thus, for QE2 to cause significant inflation there has to be some mechanism by which the additional money pouring out of the Fed turns into an increase in household income.
3. One possible mechanism would be that freshly printed money is used for real investment, that creates jobs and thereby creates increases in household income. However, interest rates are already at near record lows and companies are still not embracing real investment, so it seems unlikely that a few more tenths of a percent drop in the interest rate will stimulate significant increases in real investment. Companies make the decision to invest based on the spread between probable profit from the investment and the cost of borrowing the money to make the investment and if an investment isn't already attractive its still not going to be very attractive after rates fall a bit more.
4. The additional money being used to bid up commodity prices is not likely to result in increases in household income as long as there is excess capacity and high unemployment. Commodity sellers will simply tend to pocket the extra profits from the higher prices and choose not to share those extra profits with their workers (what pressure is there to share with workers with unemployment so high?).
5. Higher commodity prices could result in increased commodity production, which could result in increases in household income. However, the increased commodity supply from increased production will tend to moderate the price increases at the same time that the higher household income is providing income to pay higher prices, so once again inflation will tend to be blunted over time.
Why is the Fed doing this? on Econbrowser.com
I wouldn't worry too much about QE2. I don't think the Fed could cause inflation right now with any reasonable amount of QE. Here is my reasoning.
1. In an economy that is 70% consumer spending inflation cannot get very far without corresponding increases in nominal household income. If prices rise without corresponding increases in household income aggregate real demand will fall in proportion to price increases and quickly snuff inflation.
2. Thus, for QE2 to cause significant inflation there has to be some mechanism by which the additional money pouring out of the Fed turns into an increase in household income.
3. One possible mechanism would be that freshly printed money is used for real investment, that creates jobs and thereby creates increases in household income. However, interest rates are already at near record lows and companies are still not embracing real investment, so it seems unlikely that a few more tenths of a percent drop in the interest rate will stimulate significant increases in real investment. Companies make the decision to invest based on the spread between probable profit from the investment and the cost of borrowing the money to make the investment and if an investment isn't already attractive its still not going to be very attractive after rates fall a bit more.
4. The additional money being used to bid up commodity prices is not likely to result in increases in household income as long as there is excess capacity and high unemployment. Commodity sellers will simply tend to pocket the extra profits from the higher prices and choose not to share those extra profits with their workers (what pressure is there to share with workers with unemployment so high?).
5. Higher commodity prices could result in increased commodity production, which could result in increases in household income. However, the increased commodity supply from increased production will tend to moderate the price increases at the same time that the higher household income is providing income to pay higher prices, so once again inflation will tend to be blunted over time.
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