Economics: Why Inflation Is Going Away Sooner Than The Pundits Tell Us

 

(Drivebycuriosity) - If we believe some pundits "inflation isn’t going away anytime soon" ( vox.com). I beg to differ. 

Inflation has already peaked June 2022 (9.1% statista ). Since then the inflation rate fell to 4.9%, this is a drop of 4.2  percent points - 0.4 percentage points per month. If this drop continues, America´s inflation rate will reach the Federal Reserve target of 2% by November 2022.

The high inflation rate has been caused by a flood of money in the past. In 2020 & 2021 the US government flooded the economy with stimulus checks in the value of trillions of dollars (American Rescue Plan), supported by huge bond purchases by the Federal Reserve. 

The government money landed directly on the bank accounts of the Americans, blowing up the money volume M2 (bank notes & coins & deposits at banks).

 

 

Over two years the US money volume M2 jumped about 40% as a result (the charts above display a huge hunchback  fred.stlouisfed). The money deluge met a constraint supply of goods & services, partly because of Covid19. It is no surprise that prices had to increase so much (marginalrevolution).

 

 ( source)

But monetary growth peaked already in February 2021 (with plus 27%). Since then the monetary growth rates have been falling and turned negative in December 2022. In the recent months the money supply has been shrinking! "We have never seen money taken out of the economy like this in our history" ( twitter.com).

 

                     Causal Connection

The causal connection between money and inflation is known since the 16th century at least. Nicolaus Copernicus described already in the year 1522 how "too much money" causes inflation. Copernicus` "quantity theory of money" is based on observations:

The Spaniards had conquered today`s Latin America and looted the silver stocks. They send the precious metal to Europe where is was printed into coins and used as money. As a result the European money volume jumped, meeting a restrained supply of goods (agriculture, hand works) &  services. The flood of money raised suddenly the demand for scarce goods & services and caused a jump of the price level.

Elaborated studies by Milton Friedman, Karl Brunner, Allan Meltzer and many other economists (known as Monetarists) described already in the 1960s how and why the inflation rate follows the growth rate of money with a time lag (causal connection).

 

                  The Pull Of Money

I don`t expect that the general price level will fall any time soon, but I expect that prices will climb slower.

It is helpful to recall Calculus. Inflation rate is the change of the price level: First Derivative. The change of the inflation rate is the Second Derivative. 

Since inflation follows the growth of money, the inflation rate (growth rate of prices) will follow the pull of the shrinking money volume and the inflation rate will continue to drop.

 

The disinflation is supported by the Internet. According to Adobe the online prices are already falling (image above adobe.com). The company reports: "Online prices in April 2023 fell 1.8% year-over-year (YoY), marking the eighth consecutive month of YoY price decreases, with the majority of categories (11 of 18) tracked by Adobe seeing falling prices on an annual basis."

 

Even the red hot food price inflation is cooling online. The growth rate of online food prices is dropping - following the negative trend ( adobe.com).

The dropping online prices are no surprise. Computers, other electronics and many more industrial products have been getting cheaper all the time, thanks to ongoing automation. Amazon and other e-commerce companies are getting more & more efficient which translates into cost savings and lower prices for goods sold online.  

Since going online Amazon has been been obsessed with efficiency, cost cutting and delivering goods cheap, fast & reliably. They have been constructing a network of huge fulfillment centers which are very efficient and save a lot of costs. Customers spend less money & time when they get things delivered at home. 

Amazon`s rapid growth forced competitors like Walmart & Target to act similarly and to become more efficient & to curb their prices as well (Amazon Effect). Today Shopify, Wayfair and many other e-commerce companies are competing with Amazon which forces them all to sell at relatively low prices. Even Google & Facebook want a piece of Amazon`s pie and are participating in the battle for online customers. 

Before the money flood of the years 2020/21 the Amazon Effect had kept a lid on inflation by partly compensating the rising costs for services like health care & education and the climbing rents. 

Because the inflationary money flood has receded, inflation should soon come back to the low rates we enjoyed in the decades before 2020.