Disclaimer: Any opinions expressed, potshots taken, or scientific views articulated are mine, and need not represent the opinions, potshots, or scientific views of the Federal Reserve Bank of St. Louis, or the Federal Reserve System.
Steve, QE has expanded the Fed's balance sheet by roughly 400% since 2008. The main reason this expansion of the money supply has not caused inflation is that it is reversible--the Fed can simply let the bonds mature or sell them at a profit. Do you think your prescription for raising rates might cause inflation because it will result in a permanent increase in the money supply, due to the Fed's taking losses on its LSAP program? In effect, we would finally get a helicopter drop?
Why do you call the quadrupling (in nominal terms) of the balance sheet an "expansion in the money supply." The Fed could, for example, have expanded the money supply in this sense by purchasing Treasury bills and issuing reserves. But, in terms of the outstanding consolidated government debt (debt of the Fed and the Treasury), that expansion would have been of essentially no consequence, as T-bills and reserves are roughly the same thing if the reserves are just being held overnight. So, if there are any consequences of the expansion, it's in the shortening of the average duration of the outstanding consolidated government debt.So, suppose that the interest rate on reserves goes up. We know that if that interest rate is high enough, that the transfers the Fed makes to the Treasury will go to zero, and the Fed will start taking losses on its balance sheet. That really has no economic consequences. For example, suppose the Treasury had reduced the duration of the debt issued on its own, and the Fed's balance sheet were smaller. It wouldn't make any difference. See this post for more:http://newmonetarism.blogspot.com/2013/03/the-balance-sheet-and-feds-future.html