Why didn’t quantitative easing affect inflation in 2008?

A complicated issue which we can attempt to break down this way:

- First it would be good to bone up on the concept of financialization. It can be said with some confidence that the 2007–2008 financial crisis was a direct consequence of some thirty years of the U.S. converting to increasingly financialized productivity where speculation, derivatives, and debt-based financial instruments dominated profit seeking. At a fundamental level, aided as it was by loosening leverage ratios and lax oversight of financial institutions, this meant that there was “no there there” in terms of real assets. This was all pretend…psychological, high risk gambling really.

- Now if banks don’t have adequate cash reserves to cover such risky gambling, and that gambling gets exposed for what it really is (i.e. payments come due and can’t be made), then the whole game falls apart like a ponzi scheme. The “no there there” becomes a financial death spiral - lending seizes up to disrupt the credit cycle, banks and insurers go under, and economic productivity grinds to a crawl. Remember…this shift away from a production/consumption economy to a debt-servicing speculation economy meant that there wasn’t anything to take up the slack in terms of investment (well there actually was…it just wasn’t perceived to be such any longer, but we’ll get to that in a minute). So the bottom fell out, resulting among other things in tremendous deflationary pressure - especially in terms of debt deflation. [BTW, this is a classic example of how the market fails to make good decisions at a macro level…but that’s another discussion. The point is, this face-plant created a huge amount of essentially unsecured debt that couldn’t be rescued.]

- Here is where QE steps in. How do you get banks to start lending again? Well fatten their reserves of course - every dollar in reserves can lead to $1,000s in economic activity once reinvested. But..um…what if they just pocket the money and don’t lend it out? And, well, this is exactly what happened. Credit remained ridiculously tight…ironically, for much lower risk investments than had previously been gambled upon. For example, small business loans and lines of credit just could not be got, even with a sterling business credit history. That seems odd, doesn’t it? Well it is. It’s actually ludicrous. But remember that lenders had essentially “forgotten” any other investments besides their beloved debt instruments…so they just packed QE surpluses away, like rats building a nest in the dark. But remember those “deflationary pressures” I mentioned? Well they kept holding the interest rates down with voracious psycological intensity - collateral (residential real estate, for example) remained both undervalued and in an excess supply…a supply that grew rather than diminished. Which meant there was no inflation. And because that excess supply also discouraged traditional productivity (no labor, materials or other inputs were required), economic growth remained stagnant from such inactivity as well.

- Eventually, of course, the credit cycle did loosen up a bit and businesses and consumers could get loans, which in turned began to generate more economic activity. It has taken several years, though, for those deflationary pressures to relax, and increasing collateral value and pent up demand to evidence themselves. I think it’s still pretty tenuous, still in process, still uncertain, and still sluggish.
Which brings us up to the current political and economic climate, which is happily broadcasting a renewed loosening of financial restrictions, a relaxing of oversight, and and encouragement of shiny new risky gambling behaviors. The good news, of course, is that the American taxpayers are still available to socialize the risk of Wall Street high rollers - a role they seem quite happy to accept, since they voted in 2016 to make the an unstable and unsustainable U.S. financialized economy “great again.” Weehaa!

My 2 cents.

From Quora post: https://www.quora.com/Why-didn%E2%80%99t-quantitative-easing-affect-inflation-in-2008/answer/T-Collins-Logan


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