Excess Liquidity.. where did that come from?

Excess Liquidity is a characteristic of today's economic scenario, where different parts of the world are in some stages of a recovery (barring euro zone, which is still in pits). Excess liquidity, on a prima facie analysis, is a direct result of the credit crunch that happened after the sub prime crisis. Banks were not willing to lend that easily which resulted in institutions holding excess cash. There were no so much good quality assets/borrowers where they could invest/lend to. Whatever good quality assets/borrowers remained out there, hence commanded a discount in pricing. But more than this, liquidity in market is a direct result of many other factors, most specifically, en economic cycle. Certain factors are as follows: 

1. When Government borrows, by issuing Government bonds/T-notes, they reduce liquidity in the market.

2. Inversely, when the Government repurchases, they increase liquidity and pumps in money into the market. In the same way, when Central Bank decides to purchase Government bonds from the market, and give money they print in exchange, that is increasing liquidity.

3. Higher liquidity is often associated with lower interest rate, more money with the banks that they lend at lower rates, hence booming business, new jobs, demand and hence rising asset prices. 

4. So when inflation kicks in, Governments stop the bond purchase, liquidity dries up, rates rise, demand falls, prices cool.. so that's the cycle .

After years of quantitative easing, US has still not seen any signs of inflation. The reason for QE in the first place was that rates already reached 0.25 range, and no recovery was seen. Rate cuts are Central Bank's first response to vitalize economy, as it expects lower borrowing costs to result in more credit and job creation. However, due to the credit crunch where banks were too scared to repeat mistakes, that didn't happen. So the next option with the Bank was to pump in money into the market. Banks across the world are doing so (Fed), or planning to do so (Euro zone). Normally Central Bank buys the short term asset, pushing its price and lowering short term interest rate. But when rates reach close to zero, then they have to buy long term assets, pushing long term interest rates also lower. When QE tapers, rates will increase. 

With more money chasing the same assets, QE is supposed to result in inflation. However, in a low interest rate scenario,  what happens is that investors tend to hold cash, rather that investing it. Also, the fact that money is pumped in through asset purchases, that is, reducing yield on those assets, then essentially, investors tend to hold, rather than invest. So cash is attractive, resulting in demand for money, which absorbs the supply of money. It does not chase assets, and hence, no inflation happens.

So till the time the QE continues, till the Fed gets the idea that inflation is not going to go to the level they expect to put a break on this, liquidity will be in excess. Also with now oil prices facing south, through a series of factors, most importantly the global players trying to take away the negotiating power from Iran and Russia, inflation is not gonna come soon to US shores. Once they start selling assets to reduce liquidity in the market, that's when prices of bonds fall, rates increase and people start chasing assets. That's when demand for money reduces which matches reduce in supply and inflation can set in. Excess Liquidity is here to stay for some more time.