Economics: The Federal Reserve Set Course For Deflation

(Drivebycuriosity) -  Inflation rates are collapsing, following the shrinking money volume (image scottgrannis). But the Federal Reserve hiked her interest rate hikes again - stubbornly ignoring the facts. It seems that the Fed set course for deflation.

 

                      Helicopter Money

The high inflation rates of the recent months were caused by a flood of money in the past. In 2020/21 the US government - supported by massive bond purchases by the Federal Reserve -  flooded the US economy with trillions of dollars, giving the Americans enormous purchasing power. Friedman called this action prophetically helicopter money (cato ). The government money landed directly on the bank accounts of the Americans, blowing up the money volume M2 (bank notes & coins & liquid deposits at banks).

As a result in 2020 & 2021 the US money supply M2, the engine of the inflation, jumped 40% (image below). The money deluge met a constraint supply of goods & services, partly because of COVID-19 which disturbed the supply chains.  

"Inflation is caused by too much money chasing too few goods and services", notice the economists at fisherinvestments. "It is no surprise that prices increased so much", comments Tyler Cowen, Professor at George Mason University (marginalrevolution).

 

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                            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: 

Early in the 16th century Spain conquered today`s Latin America and looted the silver stocks. The Spaniards send the precious metal to Europe where is was printed into coins and used as money. 

As a result the European money supply jumped. 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).

 

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The  monetary growth 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 June M2 dropped 4% YoY ( fred.stlouisfed). 

 

 

The so-called wholesale inflation, the change rate of the producer price index, followed the pull of the shrinking money supply and dropped to 0.1% YoY and might turn negative in the coming months (source ). The online prices are already falling. Adobe reports: "Online prices continued to drop, falling 2.6% compared with June 2022 and 1.3% below May 2023" ( adobe)

The Fed ignores these inflation rates and focuses on the so-called Core PCE price inflation (plus 4.1% YoY source ). This number excludes energy costs & food prices.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 (americanprogress fisher)! Unfortunately the shelter component does not show current house prices and has a time lag of 12-18 months ( aier). As a result the so-called core-inflation is from yesterday. 

 

                  Keynesian Kabbalah

Apparently the Federal Reserve does not care about history and the elaborated studies by the monetarists. Instead the agency follows a kind of Keynesian Kabbalah and believes in mystical phenomena, like wage spirals & cost-push-fallacy (brookings).

The collapse of the inflation rates follows the monetarist playbook and proves the Fed wrong. It is highly likely that the recent interest rate hike are driving inflation rates further south. Inflation might even turn into deflation - following the shrinking money volume (negative growth rates).