Second, I flatly disagree with the idea that an increased money supply caused by government buying its own security will result in inflation. First, look at the evidence: this is exactly what Japan has spent ten years doing with little effect (on inflation or anything else). Second, there is a simple theoretical reason for thinking that “quantitive easing” (i.e. what Japan did) has little effect. The reason is thus. Securities are chunks of wealth that the owners regard as SAVINGS. Savings are portions of an individual’s wealth that they DO NOT INTEND SPENDING. Thus if for some reason someone induces an owner of a tranche of securities to convert them to cash, that cash will NOT GET SPENT. The cash will just get dumped in a deposit account. Thus there will be no effect on demand and thus no effect on inflation.

When the Japanese government induced Japanese citizens to convert their securities to cash, a significant proportion of Japanese security owners went out and bought foreign securities with the proceeds! I could have told them that would happen.

But, as you say, it is the financial sector that transmits the inflation into the real economy. We are seeing the Fed attempt to inflate by creating money now. But because banks are in such terrible shape, they are not re-lending the money. The money multiplier is crashing and consumer price inflation is not happening.

That isa problem for a central bank looking to avoid deflation.