| >That doesn't make very much sense to me. It's not as if the "new dollars" are worth $1.02, while the "old dollars" are worth $1.00. It's very much like that, actually, except it's more like the new dollars are worth $1.00 and the old ones are now worth $0.98. The important factor is time. Suppose we live on an island and have a currency we'll call a "foo". There are 100 foos in circulation. Tax collection isn't what it should be, so the president of the island borrows ten foos from the central bank (which, like the fed, just updates the computer to create them) and uses them to pay the presidential guard. When he spends those ten extra foos, the president is getting the current purchasing power of the foo. It will take some time for the value of each foo to adjust down to take into account there are now 110 foos instead of just 100. Two weeks from now everything priced in foos will have risen 10%, but since the economy didn't "know" about the extra foos the president was able to spend them at full value. >The first-order effect is: banks are owed an amount of money denominated in nominal terms, and inflation will decrease the value of those debts. That's true, but the bank isn't going to loan you money without taking inflation into account. That's why loan interest rates go up when inflation goes up. Also, the bank is borrowing the money they're loaning to you, and after they make the loan they're going to sell it off to a GSE or market investors. So someone else is ultimately holding the bag if there's inflation. >And even if this theory was true, inflation has been historically low (and below central-bank targets) for quite a few years, so whoever is pushing for higher inflation isn't very good at it. Well, yes. The problem is two-fold. The first part is in a fractional reserve system the money supply depends on qualified candidates willing to borrow. In the midst of a recession there just aren't as many of them - people without jobs aren't buying houses, and businesses aren't expanding. So less new money is created. The second part is loan defaults destroy money. If you get enough defaults you're going to get deflation. It's not like the banks didn't get their money's worth, though, as the government used every trick in the book to add money to the economy. At one point in time the government was borrowing forty cents of every dollar it spent, and the Fed was injecting more directly though QE. |