Austrian Economics and Behavioral Economics
Here is something you will not read in Ludwig von Mises' Human Action: economic incentives are superpowers.
Any analysis, economic or otherwise, must take into account base human behavior and human psychology. Simple pavlovian human responses to environmental conditions can often answer questions that esoteric theory cannot.
I am aware of no economist, including no Austrian economist, who has offered a comment or analysis on the fact that the trillions of dollars in 2008 bailouts caused no material increase in prices for over 12 years. No one I am aware of has proposed a reason "why" there was an unprecedented 12-year causal disconnect and apparent suspension of the laws of monetary physics. Some smart Austrians have even asserted that the apparent 12-year breakdown between economic cause (trillions in newly printed 2008 bailout dollars) and effect (subsequent inflation) has upended and put into question all of economic theory, including Austrian economic theory. They are equally puzzled about why we are seeing an inflation uptick only recently.
Although not an Austrian economist, Milton Friedman accurately observed that "inflation is always and everywhere a monetary phenomon"; that is, when the money supply increases, prices also increase, albeit with some lag caused by the Cantillon Effect--the first pigs at the newly printed money trough get the fattest because they can buy things at a relatively low price from sellers who do not have access to and are not aware of the money supply increase. Austrian economists agree with Friedman's propostion, and they add to it by stating that there is usually a small time lag between the money printing and generalized inflation because of the Cantillon Effect and because each individual in the economy subjectively values things differently. Because of these dynamic variables, Austrians observe that the correlation between an increase in the money supply and later increased prices cannot be measured or predicted with any finite accuracy.
I don't pretend to be an Austrian economics scholar. But I do believe I understand "why" there has been a disconnect between the 2008 bailouts and the lack of subsequent price inflation. I believe the disconnect has more to do with behavioral economics than it does with Austrian economic theory. I believe the answer lies in the writings of Cialdini and Munger moreso than those of Menger, von Mises, and Rothbard. No monetary laws have been broken. The laws governing fiat money are still Newtonian, not quantum. Austrian ecomomic theory, including subjective value, praxeology, and, the necessary and inevitable failure of all central economic planning, are all alive and well. My simplistic understanding of Austrian economics--the idea that men scheme and God (via Mr. Market) laughs--remains undisturbed.
The hypothesis is this: in August 2008, the Federal Reserve began paying banks "interest" on "excess" reserves ("IOER") held on deposit with the Fed. This very tiny economic incentive, applied to trillions of new bailout money (actually hyperpowered monetary base), has incentivized banks to hold onto the bailout money and earn interest on it rather than take the risk of lending it into everyday economy. When the Fed is concerned that the banks might start lending to Main Street, it raises the IOER rate.
The data and charts below show that IOER separated the United States into two economies starting precisely in September of 2008. The two economies are: (1) the Wall Street economy where virtually all the new money has been contained on Wall Street and where Fed lending to Wall Street gamblers has caused a nearly 4x increase stock market prices in 12 years; and (2) the Main Street economy where money and credit have been relatively tight, money velocity at record lows, and, until recently, there has been no monetary inflation/loss of purchasing power. IOER effectively neutralized the Cantillon Effect by separating the Wall Street pigs from the rest of the Main Street team. The Wall Street pigs and only the Wall Street pigs have had access to the new money trough from 2008 to 2020. Result? No Cantillon Effect.
IOER was the brainchild of Stanley Fischer, a Fed banker who, as a young central banker, advised the Israeli central bank as it experienced mass inflation in the 1980s. Fischer was Ben Bernanke's mentor and tutor. Bernanke was the implementer of IOER. Fischer, Bernanke, and Yellen have all referred to IOER as the Fed's most important "policy tool."
The charts below I believe clearly show that IOER has separated the economy in two and thus explains the 12 year lack of Main Street inflation. What explains the current inflation and should we be worried about hyperinflation? Answer: No. The reason are illustrated in the M1 (currency on Main Street) chart below.
It seems likely that the Fed is aware of the Cantillon Effect and its politically destabilizing result: the guillotine effect. The now-apparent purpose of IOER was to prevent the Cantillon Effect and avoid hyperinflation. IOER incentivized the Bailout recipients to deposit money with the Fed where it would be sheltered from the Main Street economy (and could cause mass- or hyper-inflation) and could be used instead for leveraged gambles on stocks and bonds (and therefore promote and sustain an overall psychological "wealth effect"). If IOER did not exist, the Bailout Banks would have been compelled, post 2008, to lend trillons of hyper-powered monetary base into the precarious Main Street economy. Because our fiat system is a fractional reserve system, the subsequent lending and and re-lending of this base would have the potential to exponentially multiply the Main Street money supply and thus result in hyperinflation.
That never happened. Because IOER prevented it. What did happen was, in 2020, whether by pandemic accident or psyop design, in March (yes, March) of 2020, the Fed began massive direct injections into the Main Street economy; this later included trillions in PPP loans and stimulus payments. Again, see the M1 chart below.
Because a lot of production was shut down over 2020 due to the pandemic narrative, we are now seeing the result of Fed's direct injections into the Main Street money supply. We have the same or perhaps increased demand, plus lower supply caused by shutdowns, plus more available currency for the same transactions. More money chasing the same or fewer goods equals inflation. There is nothing strange about this and this inflation does not appear to be caused by any policy change in IOR (IOER became interest on all reserves "IOR" in 2020).
It thus does seem likely that this inflation will be temporary, or "transitory" as Fed chair Jerome Powell asserts. Why? Because direct injections into the Main Street economy are unlikely to cause hyperinflation. Inflation yes. Hyper or runaway inflation? No. In a digital money world, only uncontrolled credit expansion could cause the wheels to come off of the monetary cart. Credit expansion is tightly controlled and regulated by IOR, an incentive mechanism of behavioral economics. So long as there is no change in Fed policy and the Fed does not start charging rent on reserves rather than paying interest , then Jack Dorsey is wrong and hyperinflation is very unlikely. If the Fed changed its policy and started charging rent on reserves, the Bailout Banks would be forced to lend to Main Street and I suspect we would see the hyperinflationary "crack up boom" that von Mises predicted as the inevitable end of all centrally-controlled banking systems. They aren't that dumb.
The data and charts below show that, since September of 2008, the IOER/IOR rate has acted as tightly-closed spigot that has prevented any flow of bailout money into the Main Street economy. Excess reserve deposit charts illustrate the power of the IOER/IOR economic incentive. The 2008 Bailout Banks prefer a low riskless return on trillions over very risky lending to Main Street. The M1 chart is the most telling. The chart goes vertical starting in early 202o. The data thus shows that 2021's inflation is caused by the pandemic narrative direct stimulus payments, not credit expansion and not any change in IOER/IOR policy.
Money Velocity before and after September 2008:
Excess Reserve (Monetary Base) Deposits before and after September 2008:
Household Debt to GDP Before and After September 2008:
Median CPI before and after September 2008 with rise after direct stimulus
M1 (money on Main Street) Money Supply
Wall Street Prices (the Stock Market) Before and After 2008
There has been plenty of inflation in the 12 years since the 2008 bailouts. It has all been bottled up and retained in the Wall Street economy where is has caused a 4x increase in prices. IOER/IOR has made this possible. IOER/IOR has split the U.S. economy in two: Wall Street and Main Street.
Ludwig von Mises is still right. Bureacrats cannot accurately determine the price or supply of anything. They can't determine the most important and most influential (and artificial) price in the U.S. economy--the (IOR). They cannot determine the right amount of money to supply into the Main Street economy (PPP and stimulus checks) to avoid the Cantillon Effect. Fed bureaucrats are out of touch with the market (reality) and have no skin (risk) in the game. They will always be guessing on the price of money (IOR) and the supply of money (direct stimulus). Individuals with no risk making decisions about the lives and security of others does not end well as Mises predicts in Economic Calculation in the Socialist Commonwealth. For the system to work properly, private banks will have to be willing to take risks with the bailout funds they are holding on deposit with the Fed. The Fed is preventing that by paying IOR.