As I stated frequently, I do not see that too high inflation will become a problem over the next years for most of the so-called 'developed' economies (see for example here: Is Inflation just around the corner? Part II).
Clearly, the debate about the inflation outlook remains intense with the difference in views as wide as ever. The "Big Picture" blog has just published a lengthy guest article laying down the foundations of the inflationary view (see here). I will first provide a brief summary and then comment on that view.
In short the authors "believe macroeconomic fundamentals imply longer-term US Treasury yields should be priced above 10%". The reason is that they expect inflation to rise to 10% for several years. They state: "money growth is inflation and generally rising prices are frequently derivative of that money growth...The Fed just doubled the monetary base over the past nine months...So, in monetary terms, we've witnessed a massive dose of inflation. The growth in the US monetary base is the permanent addition of money to the system."
I have several problems with this reasoning. First, I do not regard a rise in the monetary base as being the same thing as inflation. Certainly, it can cause inflation (which I understand as an ongoing rise in the general price level) but there is not necessarily a 1:1 link. As I stated previously M*V=Y*P (i.e. the money times velocity of money equals output times price level) always holds because it is an identity. But that does not tell much. Unfortunately, there are various different forms of money (from 'high-powered' central bank money to broad credit aggregates) and additionally V is not a constant.
If the broad credit aggregates fall by more than narrow money aggregates rise, then V for narrow money aggregates is likely to fall (and it has been falling sharply over the past year). Additionally, just because the central bank creates more central-bank money, that does not mean that this will be hitting the economy. The authors themselves show this chart of banking reserves:
As an aside, this article entitled 'When is rapid growth in a central bank's balance sheet not cause for concern?' makes an interesting point about bank reserve developments in New Zealand. In July 2006, the Reserve Bank of New Zealand (RBNZ) changed the monetary policy operating system from a channel or corridor system to a floor system. "Under this floor system, the RBNZ stopped offering free collateralized daylight credit to banks for settlement purposes. In other words, they removed the distinction between daylight and overnight reserves. Also under this new system, reserves were remunerated at the official cash rate (OCR), the RBNZ's target interest rate." The new level of bank reserves increased by about 400times and moved to roughly NZD 8 billion (which corresponds to almost 25% of GDP). However, M1 was unmoved by this.
As the US Fed has started to pay for excess reserves, it should be expected that at least part of the rise in bank reserves is permanent and even once the ability of banks to extend credit is normalised and the demand for credit by corporates and households is rising as well, not all reserves will be used up.
So, in short broad based credit aggregates are falling by more than narrow-based monetary aggregates are rising. However, once broad-based credit aggregates are rising again (which can take a long time as it needs both, banks which are willing to lend and households/corporates which are willing to borrow), we should also expect narrow-based monetary aggregates to fall again. The ultimate inflationary pressure will be very limited and take a long time before it becomes evident.
For the time being, we still have too little money chasing too many goods resulting in disinflation or as in the case of Ireland in significantly negative inflation (or does anyone dare to say: deflation?):