Use access key #2 to skip to page content.

Price inflation due to monetary inflation, and interest rates?

Recs

5

October 13, 2013 – Comments (10)

i think my brain must not be working right today....

 

So a huge increase in the money supply will drop interest rates because there are now more loanable funds....but this increase in the money supply will also lead to future price inflation.  Future price inflation leads to an increase in interest rates.

 

So increasing the money supply obviously can't both raise and lower interest rates at the same time...so which is it? 

10 Comments – Post Your Own

#1) On October 13, 2013 at 5:51 PM, somrh (86.56) wrote:

Your problem might be solved if you distinguish between nominal cost of capital and real cost of capital.

Let's suppose you have an increase in money supply and let's suppose there is higher inflation as a result (or at least expectations of higher inflation).  The real cost of capital could be pushed lower (as funds flow into buying up assets) but the nominal cost of capital could go higher (due to the inflation expectations being built into it).

So basically you would have:

Nominal Cost of Capital = Real Cost of Capital + Inflation Expectation

The result would be that there would be upward pressure on the prices of inflation hedged assets (TIPs, real estate, stocks) and downward pressure on the prices of assets which aren't inflation hedged (most bonds).

Of course right now inflation expectations are still pretty low (10 Year nominal - Real = 2.2%)

Report this comment
#2) On October 13, 2013 at 6:48 PM, Valyooo (99.53) wrote:

I'm not understanding.....so the inflation expectations push bond prices down, I understand that...but they push bond prices down because rates go up....but an increase in supply of money usually makes rates go down, no?

 

I'm not seeing how nominal and real cost fits into this.  clearly im a little slow today 

Report this comment
#3) On October 13, 2013 at 7:25 PM, somrh (86.56) wrote:

Think of there being 2 different variables: Real rates and Expected Inflation (and maybe risk premium for other assets)

So here's what it looks like:

TIPs = Real Rates

Treasury = Real Rates + Inflation Expectation

So duing the whole QE thing, real rates declined. ... at least until the tapering suggestion came forward. 

Inflation expectations haven't really budged. They even have gone down a bit since before the crisis.

Right now it looks like:

TIPs = 0.5%

10Y Treasuries = 0.5% + 2.2% = 2. 7%

But let's suppose money printing results in real rates to decline (asset prices to rise). Let's put a number on of -1%. And let's suppose inflation expectations go to 5%.

TIPs = -1%

10Y Treasuries =  -1% + 5% = 4%

So in this scenario TIPs would go up in price and regular treasuries would go down in price. 

Stocks and real estate would probably both go up in price but we'd have to model in a risk premium as well.

Report this comment
#4) On October 13, 2013 at 8:54 PM, Valyooo (99.53) wrote:

Makes sense.  However, in the future if the fed announces an increase in the supply of money, how will I know if it will decrease rates (due to increased loanable funds) or increase rates (due to inflation expectations)?

 

Fed QE just gave more money to the bank as reserves, so I guess it just decreases rates, but doesnt expand money supply with no loans 

Report this comment
#5) On October 13, 2013 at 10:26 PM, somrh (86.56) wrote:

Yeah, pretty much. I mean M0 may even lag inflation slightly. See Kydland and Prescott Business Cycles: Real Facts and a Monetary Myth.

The silly money multiplier model (among other things) needs to be removed from textbooks

Report this comment
#6) On October 13, 2013 at 10:56 PM, Valyooo (99.53) wrote:

Are you a MMT student (or believe, follower, I don't know what the word is for somebody who adheres to the beliefs of)?  I've just started reading some of their ideas in the last week or two and have a lot of questions, it's very interesting to me.

Report this comment
#7) On October 14, 2013 at 12:20 PM, somrh (86.56) wrote:

I honestly haven't read too much from the MMT crowd. I am however sympathetic to some views that have similar geneaologies. Here's a few things you can check out if you're interested.

Understanding the Modern Monetary System

I think Cullen doesn't consider himself MMT because he doesn't like some of the prescriptive measures the MMT crowd focus on. I think he's more interested in a descriptive account. Anyway, he has a blog here: Pragmatic Capitalism.

The other individual I've read quite a bit from is an Australian economist by the name of Steve Keen. Keen probably falls under "post-Keynesian" category but again, similar genealogies. 

He has a blog here: Debtwatch.

He also has a book critiquing neoclassical economics:  Debunking Economics.

One of the important threads to all of this is Hyman Minsky. So if you haven't read his Financial Instability Hypothesis, you probably should take a look. Steve Keen has been working on modeling it and has some software developed for that aptly Minsky.

Report this comment
#8) On October 15, 2013 at 1:25 AM, Valyooo (99.53) wrote:

Wow a crap load of great info. Thank you very much. 

 

Seems ma like this blog is just you and I. What's your deal? 

Report this comment
#9) On October 15, 2013 at 1:54 PM, somrh (86.56) wrote:

Apparently we are the only two here. Maybe there are some lurkers reading. Who knows.

I did forget to mention Steve Keen has a youtube channel as well. He posts a lot of his lectures online.  Check his playlists. For example, his behavioral finance lectures cover some of the material from his book (if you prefer watching videos or just like free).

Report this comment
#10) On October 17, 2013 at 8:23 PM, Valyooo (99.53) wrote:

I lost this blog when the site shut down.

 

Any and all lectures you have, please send my way.  I do pharmaceutical sales....I drive 8 hours a day...I love anything to listen rather than read.

 

Do you work in finance? 

Report this comment

Featured Broker Partners


Advertisement