Money growth alone does not map into inflation. That is a myth and markets have learnt that. But joint monetary and fiscal expansion is a different matter, and markets may learn that next.
“Outside money” growth can sit as dead reserves for a long time. Without a rise in final expenditure that is captured by gdp accounts no demand impetus is created. That’s the same as saying velocity has fallen. Demand growth is most often accompanied by a rise in credit or loans or “ inside money” in which case velocity remains stable. Merely stating velocity is falling doesn’t explain the fall
Could the conclusion be simplified further to say: growth in M0(1) has a very low(zero) probability of causing inflation, but M4(or similar) growth has a decent probability of causing inflation, since M4 is linked much more to demand and credit creation than M0?
Post 2008 V collapsed hence M HAD to rise since in the short run Q is inelastic P would have collapsed causing huge price deflation (and probably a spiral). I believe initially the FED didn't know how big M should be and V is tricky to measure except ex-post. However, the FED has had more than a decade of practice and is almost certainly aware of and quite capable of adjusting monetary policy. Their biggest problem was trying to INCREASE P, namely inflation. Now Q is still inelastic in the short run but the other side of the equation MV are BOTH likely moving up. During COVID V was likely down. But post-stimulus (and post-COVID) it is likely to head up. It is hard to imagine inflation isn't headed up. How well this is managed remains the issue.
Great article which shows that economic laws are not independent of time and space.
- I agree that there is no simple link between money growth and inflation
- For EM (especially Argentina) I think the stronger trade off between money growth and inflation can be explained by dollar liabilities of private and central bank respectively.
This COVID-19 situation has both monetary and fiscal expansion, but demand for money and output growth shall be absorbing the "easy money", given prices have not risen yet...
If the Fed didn't buy those UST then rates would've been higher and bond prices lower. That's inflation in the bond market. Furthermore, higher rates would have led to falling asset prices (homes) and with that a negative wealth effect and likely lower prices as measured by CPI. The fact that CPI is higher than it would have otherwise been absent QE is inflation. If gas should be 50 cents a gallon but it's 2 dollars a gallon that's still inflationary.
QE replaces longer bond with reserves (equivalent to overnight bills). As Banks do not loan out reserves, there is no channel to aggregate demand. There could be asset price inflation though....
I guess the fundamental question is "Have actors in the economy changed (implicitly if not explicitly) the way they define money?" Many things have risen in price apart from labor.
Inflation is intrinsically demand-supply imbalance phenomenon. I think there is one critical point missing in your analysis - when public spending is offsetting a severe increase in the private saving rate there is no increase in aggregate demand and hence no inflation. 2020 is not different to 2008/09. However, depending on the GA election outcome 2021-2024 might be different from 2010-2014...
“Outside money” growth can sit as dead reserves for a long time. Without a rise in final expenditure that is captured by gdp accounts no demand impetus is created. That’s the same as saying velocity has fallen. Demand growth is most often accompanied by a rise in credit or loans or “ inside money” in which case velocity remains stable. Merely stating velocity is falling doesn’t explain the fall
Thank you, Jens. Great blog.
Could the conclusion be simplified further to say: growth in M0(1) has a very low(zero) probability of causing inflation, but M4(or similar) growth has a decent probability of causing inflation, since M4 is linked much more to demand and credit creation than M0?
I may have a simplistic view on the issue but no one seems to recall
"Monetarist theory is governed by a simple formula: MV = PQ, where M is the money supply, V is the velocity (number of times per year the average dollar is spent), P is the price of goods and services and Q is the quantity of goods and services." (https://www.investopedia.com/terms/m/monetaristtheory.asp#:~:text=Monetarist%20theory%20is%20governed%20by,quantity%20of%20goods%20and%20services)
Post 2008 V collapsed hence M HAD to rise since in the short run Q is inelastic P would have collapsed causing huge price deflation (and probably a spiral). I believe initially the FED didn't know how big M should be and V is tricky to measure except ex-post. However, the FED has had more than a decade of practice and is almost certainly aware of and quite capable of adjusting monetary policy. Their biggest problem was trying to INCREASE P, namely inflation. Now Q is still inelastic in the short run but the other side of the equation MV are BOTH likely moving up. During COVID V was likely down. But post-stimulus (and post-COVID) it is likely to head up. It is hard to imagine inflation isn't headed up. How well this is managed remains the issue.
Great article which shows that economic laws are not independent of time and space.
- I agree that there is no simple link between money growth and inflation
- For EM (especially Argentina) I think the stronger trade off between money growth and inflation can be explained by dollar liabilities of private and central bank respectively.
provoking
link us to the fiscal theory of the price level
This COVID-19 situation has both monetary and fiscal expansion, but demand for money and output growth shall be absorbing the "easy money", given prices have not risen yet...
If the Fed didn't buy those UST then rates would've been higher and bond prices lower. That's inflation in the bond market. Furthermore, higher rates would have led to falling asset prices (homes) and with that a negative wealth effect and likely lower prices as measured by CPI. The fact that CPI is higher than it would have otherwise been absent QE is inflation. If gas should be 50 cents a gallon but it's 2 dollars a gallon that's still inflationary.
QE replaces longer bond with reserves (equivalent to overnight bills). As Banks do not loan out reserves, there is no channel to aggregate demand. There could be asset price inflation though....
so you so clever over the past, what is your forecast now?
I guess the fundamental question is "Have actors in the economy changed (implicitly if not explicitly) the way they define money?" Many things have risen in price apart from labor.
What about the increases in stock markets and house prices over the last 20 years
Inflation is intrinsically demand-supply imbalance phenomenon. I think there is one critical point missing in your analysis - when public spending is offsetting a severe increase in the private saving rate there is no increase in aggregate demand and hence no inflation. 2020 is not different to 2008/09. However, depending on the GA election outcome 2021-2024 might be different from 2010-2014...
My question would be about the IPC measure of inflation that doesn't capture huge increases in house and other asset prices.