I frequently wonder whether the regulatory changes made by the Federal Reserve over the last 40 years have changed the monetary and banking systems to the degree that Paul Volker’s strategy for lowering inflation is not as effective as it used to be. Some of those changes include substantially increasing the amount of reserves that banks must keep with the Federal Reserve and the interest that the Fed pays on those reserves.

9 comments… add one
  • steve Link

    That would have been my third thought. My second would have been did the banks and finance sector figure out ways to get around regulations and even just normal attempts at trying to lower inflation? My first thought would have been that maybe we just dont understand inflation and its causes nearly as well as we thought. That while there are commonalities in different inflation events that doesnt mean they are all the same and will respond to exactly the same interventions.


  • I think we understand inflation well enough. Perhaps a problem is in conflating two distinct phenomena into one: price increases and inflation. Price increases are consequences of supply and demand. Inflation is a monetary phenomenon—when the increase in money exceeds aggregate product.

    It is quite possible for the two to happen at the same time and that is what occurred as a consequence of the policy responses of two administrations to COVID-19. Or, at least, that’s what they were using as an excuse.

    What I think has changed is that due to the greatly increased reserves put in place after the panic of 2008 (and the interest paid on the reserves) the overnight interbank loans have decreased as a percentage of the total. That plus consolidation (also a consequence of the increase in reserves required).

  • TastyBits Link

    @Dave Schuler
    … Inflation is a monetary phenomenon—when the increase in money exceeds aggregate product.

    I would call inflation a production capacity phenomenon. Through multiple regulations, the money supply and production capacity have become de-coupled. With de-industrialization and importation, financialization is how money is produced to buy goods.

    (I supported Trump’s tariffs, but I now realize that re-industrialization will not be allowed. I think financialization is bad, but dollars are the only good being mass produced.)

    M2 has been decreasing which would indicate deflation, but the US produces few real goods. Shutting down the economy for a bad flu has consequences. So, the rest of the world stopped producing tangible goods, but the US financial sector kept producing money.

    Supply chains have been distorted, and it just cascades.

    If the world worked like Econ 101, paying interest on increased reserves in a Zero Interest environment would remove money from the economy, but that is not how finance works. It causes distortions in the financial system, and money gets created and destroyed where it should not. These cascade causing further distortions.

  • Drew Link

    “Perhaps a problem is in conflating two distinct phenomena into one: price increases and inflation. Price increases are consequences of supply and demand. Inflation is a monetary phenomenon—when the increase in money exceeds aggregate product.”

    I was going to respond earlier, but even in semi-retirement I have duties. My comment was going to start with the fact that steve makes an arguable point. But Dave laid it all out.

    I can only augment with this. Energy is a perfect example of the issue. It is ubiquitous. Absolutely everywhere in any modern economy. So Uncle Joe goes to war with fossil fuels and gives bjs to solar and wind, deadweight loss expenditures. Inflation!!!! But only sort of. As Dave pointed out, “inflation” is monetary, but Joe is creating what used to be called supply shock inflation. But guess what? Energy price increases go to food, home expenditure, etc.

    But then guess what, if your spend money on food and energy, then you can’t spend it on X, Y, Z. (Not inflation, per se, but a problem) And then people are pissed. So define it as you want, its a problem.

    Good luck steve. America is not as dumb as you, clinging to the belief that their life is wonderful. They have checking accounts………

  • Larry Link

    Can’t help yourself can you Drew!?

  • steve Link

    US produces more oil than any country, ever.



  • Drew Link

    Larry –


    And just look at steves citation, meaningless to the issue; you can see why. Its just arrant nonsense.

    I would note that Tasty and I have a fundamental disagreement on inflation. He cites “financialization,” whatever that means. I simply note that the Fed credits FRBanks so they can purchase Treasury bonds (debt)
    (even though that fundamental concept seems to have eluded our Chairman ofthe Counsel of Economic Advisors) . Now THAT’s inflationary. But at least Tasty makes arguments. Steve just posts stuff willy-nilly that he doesn’t have a clue how to interpret.

  • TastyBits Link


    Financialization is what happens to an economy when a country refuses to allow the production of goods.

    Securitization is one aspect. In the pdf you linked to a while back explaining it, there was an image with a thin line showing the output being used as the input. That line is financialization, but it is not limited to securitization.

    Asset inflation is another aspect.

    (I forgot I wanted to start calling it securitization.)

    Using the financial system as the leading manufacturing sector is bad, but when production of tangible goods is outlawed, the country needs to produce something to trade for the goods we refuse to manufacture.

    No matter what anyone thinks of the Chinese, they are not so stupid to trade washing machines for Facebook accounts or even stock shares. So, US dollars become the most tangible product used for trade.

    As I stated before, most people that use the term have no idea what it means. Ironically, most support the policies that make it required, and even more ironically, financialization is the reason for the wealth gap.

    Until recently, I thought it would be possible to reshore manufacturing, to the US or nearby countries. It is not, and until the next major war, it will not be.

    To reduce inflation, raise capital requirements and tighten banking regulations. Voila, money production will dramatically decrease, and this will cause real deflation (not simply an M2 decrease).

    It will not happen. While the price of an iPhone will decrease, there will be less money for everything, and users will not be able to upgrade as frequently. Consumers will squeal. Politicians will squeal. Capital requirements and banking regulations will be relaxed, and at some point, @steve will begin screaming about “liar’s loans”.

  • steve Link

    I guess I needed to add this.

    ” So Uncle Joe goes to war with fossil fuels”

    We need Uncle Joe to go to war with some of our other industries.


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