The Fed's balance sheet expansion may be slowing inflation

Coins and bills in circulation make up only 10% of the money supply today, Deutsche Bank Securities chief economist Torsten Sløk points out in a note to clients.

What it means: The majority of the money supply is now used by the Fed for its balance sheet and in the banking sector to purchase financial assets.

• As such, the velocity of money has slowed dramatically, and "an increase in money supply relative to GDP is having a negative impact on inflation," Sløk says.
• "[Y]ou can increase the Fed balance sheet and the money supply as much as you want, if the money goes into asset transactions rather than GDP transactions it will not be inflationary."

Background: "The velocity of money is the frequency at which one unit of currency is used to purchase domestically-produced goods and services within a given time period," according to the Fed.

• "In other words, it is the number of times one dollar is spent to buy goods and services per unit of time."

The bottom line: Velocity looks set to slow further as the central bank ramps up its balance sheet expansion to an expected level of nearly half of U.S. GDP this year.

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