Normally, inflation is expected to rise when central banks expand their balance sheets or enact other highly accommodative monetary policies over a protracted period of time.

However, despite such action by central banks throughout the past half-decade, inflation remains stubbornly low worldwide. There are several explanations for this phenomenon, including an aging population, technological innovation and a dearth of fiscal stimulus.

In our view, the growth of—and shifts in—the composition of what we term the “effective money supply” have kept inflation and economic growth subdued.
The effective money supply comprises the following:

  1. Money at zero maturity (MZM), which is the total amount of money in the economy that is immediately accessible at par value to individuals and organizations.
  2. Broad money, which consists of the other two components of the effective money supply, and is the sum of all money-like assets that can be quickly sold or used as collateral for a loan in order to be monetized.

Broad money encompasses a larger share of the effective money supply than MZM and includes broad public money, such as Treasury and agency securities; and broad private money, including investment-grade corporate debt, senior tranches of asset-backed securities, and highly rated non-agency, residential mortgage-backed securities (RMBS). We can consider these securities as money because they can be easily liquidated, used to purchase other assets, or used as collateral for loans at a moment’s notice so that their owners could purchase other assets. While public money can be considered a bit more money-like than private money (e.g., Treasury securities can be used to purchase corporate securities), private money tends to produce a greater economic impact.

The effective U.S. money supply is growing at a steady pace, but the mix of money creation has changed in ways that are detrimental to higher growth and inflation. Such trends also exist globally and in some countries are even more pronounced. For example, Europe has seen substantial fiscal retrenchment and flat or negative growth in broad public money, alongside stagnant or lower growth in broad private money.

Ultimately, massive rounds of quantitative easing by central banks in recent years, which were supposedly the equivalent of printing money, have actually done little to increase the effective money supply’s growth rate. This failure may explain why inflation has not crept up.

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