Why credit deflation is more likely than mass inflation

The banks are momentarily paralyzed because their solvency is uncertain and their underlying capital is frozen. The liquidation of bad debt will happen eventually, but the Fed just wants to inflate at all costs. When liquidation starts to happen, all this money will flood into the real economy, with the multiplier at full throttle.

Instead, the US Government and Fed should have allowed the liquidation to happen, preferably sooner than later. In our timeline, we get both frozen credit (and collapse) and inflation. In a better scenario, we would have gotten just a sudden collapse, with faster recovery.

Some of the key points of the paper:

Money multiplier theory, as implemented through fractional reserve banking, has been broken in the U.S. through alternative instruments(e.g. money market accounts), and has not controlled bank lending policy in the last 20 years.

The Fed persists in trying to make banks lend more, and has settled on taking on mortgage debt as the best means of doing so. Avoidance of the complete collapse causes homeowners to stay put, reducing labor mobility and increasing unemployment.

Fed policy and bank policy are determined by their "class" in society - the Fed is politically motivated and will pursue inflation even if it ruins the economy. Bankers will accept deflation so as not to cause a collapse. Japan is alluded to; it has a strong banker class that fought against pressure to inflate. The Fed is a stronger entity than the equivalents in Japan, but bankers are still largely unresponsive to its actions.

The paper concludes that a slow, deflationary economy will persist until the Fed releases the mortgage debt.

(I don't really agree, but don't have specific thoughts yet.)

My take-away:

1. Fractional reserve banking always leads to mal-investments which must either be liquidated or papered over with money (inflation). If the malinvestments are large, inflating the currency can cause the currency to collapse in hyperinflation.

2. Liquidation (bankruptcies and transfer of wealth from debtors to creditors) is unpopular so politicians tend to avoid it. Politicians will naturally pursue an inflationary policy to avoid the wrath of the voters.

3. Bankers who profit enormously from fractional banking want to avoid currency collapse at all costs.

4. The bankers who control the federal reserve will seek to slowly liquidate to avoid becoming politically unpopular. Their biggest danger is that Congress will seize control of the Fed and force it to overinflate and thus destroy the currency and the Fed with it.