When the most recent recession began in December 2007, there was no reason at first to believe that it was any different from those that have taken place about every six years in the postwar era. But it soon became apparent that this economic downturn was having an unusually negative effect on the financial sector that threatened to implode in a wave of bankruptcies. The Federal Reserve reacted by doing exactly what it was created to do — be a lender of last resort and prevent systemic bank failures of the sort that caused the Great Depression and made it so long and severe.
As the Fed lent freely to banks and other financial institutions, its balance sheet grew very rapidly. The reserves of the banking system grew concomitantly; reserves are funds that banks have available for immediate lending that theoretically should lead to credit expansion and new investment by businesses, durable goods purchases by households and so on.
Federal Reserve Bank of St. LouisDuring the inflation of the 1970s, most economists became convinced that if the Fed adds too much money and credit to the financial system it will inevitably cause prices to rise. Since the increase in the money supply in 2008 and 2009 was unprecedented, many economists reacted fearfully to the Fed’s actions.
Given the order of magnitude of the increase in bank reserves, from virtually nothing to more than $1 trillion almost overnight and now to more than $2 trillion, it was not unreasonable to be concerned about the potential for Zimbabwe-style hyperinflation.
But inflation fell rather than rising. In the five and a half years since the start of the recession, the consumer price index has risen a total of 10.2 percent. In the five and a half years previously, it rose 17.7 percent. That is, the rate of inflation fell by almost half.
Now, I don’t expect all the people who filled The Wall Street Journal’s editorial page in 2008 and 2009 predicting an imminent rise in inflation to offer a mea culpa, but at some point I think the inflationphobes should at least stop saying that hyperinflation is right around the corner.