Why ECB quantitative easing program may not achieve the much needed results?
If we follow the economic theory, an increase in the money supply should cause inflation and therefore price inflation. But here comes the tricky part. Most economists do not make the difference between these two concepts. Inflation is an increase in the overall money supply and CREDIT. Price inflation is a rise in the GENERAL level of prices, a consequence.
Turning to the FED’s policy, we see that quantitative easing did NOT achieve a rise in the general level of prices. The FED’s stimulus caused growth only in the financial assets, lowering their yield, reaching zero level (short-term government bonds). Interest rates also reached level zero. Here is where things matter. The FED can only offer cheap credit, but can not force it on people. Why is this so important? In order for price inflation to occur, velocity of money is a much needed factor. You can have huge price inflation and little inflation, but you can not have huge inflation and expect a huge price inflation without velocity. That is why we saw an enormous bull market in stocks, bonds and other FINANCIAL assets, but not in commodities, precious metals. The CRB (Commodity) index, precious metals even oil are in a long-term bear market, regardless of the previous (FED’s) and forthcoming (ECB’s) stimulus. The question is, what is the current state of money velocity?
M1 and M2 are the most important, when analyzing velocity, because they are the most narrow. Velocity remains unchanged during the stimulus program.
M1 includes cash and checking deposits.
The velocity of M1 is currently at the level of the 70’s.
M2 includes saving deposits, money market mutual fund, other deposits, which can be easily converted into cash.
The velocity of M2 is below the 1960’s level.
Conclusion: Money velocity is at history lows, remaining in a downtrend, regardless of any monetary injections.
Janet Yellen, the Chair of the Board of Governors of the Federal Reserve System said, the FED is still cautious and struggles in reaching its 2% inflation target. That is why interest rates remained unshaken.
Are we seeing the same scenario in Europe? Probably!