Thread by @MacroAlf

Inside money and outside money.
That's your easy way to think about what operations are (at least short-term) inflationary and which ones are asset price inflationary only.
Inside money never reaches the real economy.
Outside money does.
1/10

If the govt spends money it does not plan to collect taxes for, new outside money has been created.
A bank making a new loan literally credits your account out of nowhere (no deposits or reserves strictly needed, just capital and willingness to borrow/lend).
Outside money.
2/10

Can you see how this might be short-term inflationary? Expansion of credit or net govt spending boosts aggregate demand temporarily. Ceteris paribus and with a small lag, this pushes prices up. 2020 is a prime example: massive credit creation + supply bottlenecks = inflation
3/10

Outside money in the form of credit reaches the real economy boosting aggregate demand.
Now let's talk QE.
QE only creates inside money.
The CB changes the composition of institutions' asset side: from say 50 bonds, 0 cash equivalent to say 20 bonds and 80 cash equivalent.
4/10

The CB creates reserves on the liabilities' side to match their bond buying on the asset side.
The private sector gets an asset swap: more zero duration inside money (reserves), less bonds.
Somebody MUST own these reserves.
NO, banks can't lend these reserves.
Inside money
5/10

The idea of money velocity assumes that sooner or later those reserves will be lent out.
So ''velocity is now dropping'' and sooner or later it will increase.
The reserves simply CANNOT be lent out.
Banks create new money when lending, they don't use existing reserves.
6/10

Zero or 1 quadrillion reserves is irrelevant for bank lending. Irrelevant, zero.
Reserves are used to settle interbank payments and can be lent within the interbank system, but can never reach the outside world.
They are inside money.
7/10

Obviously, QE suppresses volatility and generates a constant bid for risk-free assets. And it also forcefully changes the composition of portfolios towards more zero-duration, zero-yielding assets.
This might encourage investors to increase their appetite for risky assets.
8/10

When risk-free real interest rates are negative and there is very little volatility + left-hand tails are cut short by CB intervention, the ''virtuous'' cycle of risky asset prices going up feeds itself.
Inside money creation helps explaining asset price inflation.
9/10

20 years of QE didn't generate inflation because...well, QE is not inflationary.
Another 20 years of QE won't generate inflation either.
QE + fiscal leads to boom and bust sugar rush, short-term inflationary spikes.
But for every fiscal boost there is a cliff.
10/10