Longer Term -- Monetary Policy

It is gospel among central bankers that provision of excessive money growth over time will
eventually lead to price inflation which will tend to accelerate to levels that are unacceptable to
the execution of sound monetary policy. The period of major quantitative easing of policy in the
wake of the Great Depression and lasting until the end of WW2 swelled the monetary base hugely
and was never corrected. There were a number of factors that contributed the dramatic inflation
of the 1968 - 82 period and it can be argued that the swelling of the monetary base in years prior
probably contributed to it. Looking out longer term, today's central bankers are concerned that the
major QE programs of recent years, if not corrected in some form could provide the raw material
for a new round of major inflation at some point down the road. The thinking here is that even if
there is no immediate risk, inflation could well up again even if it is ten years out or longer.

The mammoth excess reserves that now  sit in the world's major banking systems are of major
long term concern to the central banks. Programs to reduce the size of central bank balance sheets
directly or hold them in check by paying competitive interest rates on these reserves are two
methods under review. Suffice it to say that plans can be expected to be developed which will
provide far less proportionate liquidity than investors and traders have become accustomed to
over most of the last decade. Since such tightening of policies have not been tried before on a
major scale, there are elements of sizable risk that may only become apparent as these programs
unfold.

The Fed currently plans to experiment with reducing the size of its balance sheet in the months
ahead in combination with a program of continuing to gradually increase the level of short term
interest rates as the cycle of the economic expansion cycle plays out.

With the economic depression of 2008, the world entered a pro-deflationary environment because
the preceding global economic expansion and the initial bounce of economies after the 2008-2009
downturn resulted in the development of large excess global productive capacity. The issue
of low operating rates is next on this exploration of the long term.