“Inflation is always and everywhere a monetary phenomenon.” (Milton Friedman)
M2 Not Important?
Growth in the money supply, specifically M2, “doesn’t really have important implications.” (Fed Chairman Jerome Powell 23 Feb testimony to Congress)
June’s inflation index jumped 5.4% from a year ago, the highest reading since August 2008, which surprised the experts, writes the WSJ.
The Fed in Its Ivory Tower
But Chairman Powell, who is neither a banker nor an economist, and his cohorts should start paying attention to the money supply. Money not only matters, it dominates.
Americans are repeatedly told that the most recent upticks in inflation are anomalous and “transitory.”
“Wrong,” argues the WSJ.
The inflation upticks aren’t temporary and were predictable, driven by an extraordinary explosion in the money supply. Since March 2020, the M2 has been growing at an average annualized rate of 23.9%—the fastest since World War II.
There is so much money out there that banks don’t know what to do with it. Via reverse repurchase agreements, banks and money-market funds are lending money to the Fed to the tune of $860 billion. That’s unprecedented.
Milton Friedman’s Model
… consider a monetarist compact model for determining national income. That famous model was displayed on Milton Friedman’s California license plates. It’s compact:
- MV=PY, where M is the money supply,
- V is the velocity of money (the speed at which it circulates)
- P is the price level
- Y is real gross domestic product
Inflation Baked Into the Cake
Plug numbers into the model and solve for M, and money supply (M2) should be growing at around 6% a year for the Fed to hit its inflation target of 2%. With M2 growing at nearly four times the “ideal” rate since March 2020, inflation is baked into the cake, and it’s likely to persist.
By the end of the year, the year-over-year inflation rate will be at least 6% and possibly as high as 9%.
Some who like to throw cold water on monetarism argue that the velocity of money has collapsed and will mitigate the inflationary impact of the rapid growth of the money supply.
Velocity did collapse with the onset of COVID. Velocity, however, is on track to pick up until the end of 2024. Consequently, velocity will grease the monetary wheels. That’s why inflation might hit the high end of our forecast range.
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