Monetary Base

Greg Mankiw has reassuring comments on this scary chart:



He writes: "It is true that the monetary base is exploding. See the above graph. Normally, such surge in the monetary base would be inflationary. The textbook story is that an increase in the monetary base will increase bank lending, which will increase the broad monetary aggregates such as M2, which in the long run leads to inflation.

That is not happening right now, however. The broader monetary aggregates are not surging. Much of the base is instead being held as excess reserves.

But, you might ask, won't the inflationary logic eventually take hold as the economy recovers and banks start lending more freely? Not necessarily. Recall that the Fed now pays interest on reserves. As long as the interest rate on reserves is high enough, banks should be happy to hold onto those excess reserves. That should prevent a surge in the monetary base from being inflationary."