Economics: Why Is Inflation Collapsing?

 (Drivebycuriosity) - Inflation is collapsing. The inflation rate slid from 9.1% in June 2022 to 4.0% (cnbc). This is a drop of 5.1 percentage points - falling a monthly average of minus 0.46 percentage points - and more than halfway to the Federal Reserve´s inflation target of 2%. 

I expected the collapse. Since early March ( driveby) I wrote already 8 blog posts explaining the phenomena.

                    Helicopter Money Gone

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). Milton Friedman described this as helicopter money (cato ).

 

 

Over two years the US money volume M2 jumped about 40% as a result (the charts by the Federal Reserve of St. Louis 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 had already peaked 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 volume has been shrinking! In April M2 dropped 4.6% YoY.  "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

It might be helpful to recall Calculus. The 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.

 

P.S. The media also report that the so-called core-inflation stubbornly hoovered at 5.3%. This measure ignores the drop of energy & food prices ( fisher). Is energy not important? Don´t we need food? And the core-inflation has another issue. The number is artificial inflated by including a component for shelter, a mix of rents & house prices, which counts for 42% of the core-inflation! Unfortunately the shelter component has a time lag of 12-18 months ( aier). As a result the so-called core-inflation is from yesterday. Unfortunately the inept Federal Reserves bases her decisions on it.