A friend tipped me off to this BIS paper from 2009. It looks into unconventional monetary policy and the inflationary consequences of adding a huge amount of reserves to the system. The abstract reads as follows:
The recent global financial crisis has led central banks to rely heavily on “unconventional” monetary policies. This alternative approach to policy has generated much discussion and a heated and at times confusing debate. The debate has been complicated by the use of different definitions and conflicting views of the mechanisms at work. This paper sets out a framework for classifying and thinking about such policies, highlighting how they can be viewed within the overall context of monetary policy implementation. The framework clarifies the differences among the various forms of unconventional monetary policy, provides a systematic characterisation of the wide range of central bank responses to the crisis, helps to underscore the channels of transmission, and identifies some of the main policy challenges. In the process, the paper also addresses a number of contentious analytical issues, notably the role of bank reserves and their inflationary consequences.
Here is the key passage on reserves and inflation for those of you who won’t want to wade through the full paper:
Is financing with bank reserves uniquely inflationary?
The proposition that highlights the inflationary consequences of financing via bank reserves is closely related to the first. If bank reserves do not contribute to additional lending and are close substitutes for short-term government debt, it is hard to see what the origin of the additional inflationary effects could be. The impact on aggregate demand, and hence inflation, would be very similar regardless of how the central bank chooses to fund balance sheet policy. For example, it is not clear how inflationary pressures could be more pronounced in a banking system that keeps its liquid assets in the form of overnight deposits at the central bank compared to one that holds one-week central bank or treasury bills.
The same would apply to concerns about the “monetisation” of government debt, whereby the central bank purchases government bonds either in the primary or secondary market.
So there you go: “If bank reserves do not contribute to additional lending and are close substitutes for short-term government debt, it is hard to see what the origin of the additional inflationary effects could be.”
That’s exactly what I’ve been telling you and that’s exactly what we have witnessed ever since the Fed and other central banks started easing.
The inflation, if it comes at all then, happens only because of changes in private portfolio preferences and not because of the central bank’s swapping bank reserves for short-term government debt:
When assets (and liabilities) are imperfect substitutes, changes in relative supplies brought about by central bank operations materially affect the composition of portfolios and alter behaviour.
And again, that is also what we have seen with asset markets.
Source: BIS (pdf)