Economics: When Will Inflation Turn Into Deflation?

  (Drivebycuriosity) - The inflation rates are collapsing. Above you can see the so-called wholesale inflation, the change rate of the producer price index ( source). It dropped to 0.1% in June, the lowest since deflation in 2020.

 

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Above follows the so-called head inflation, the change rate of the consumer prices. It`s called so because it make the headlines in the media. This index adds services which are around 70% of the economy, including rents & house prices. This measure dropped to 3% in June, a drop of 6.1. percentage points in 12 months.

 

 

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Above you can see online prices, which are already falling. Adobe reports: "Online prices continued to drop, falling 2.6% compared with June 2022 and 1.3% below May 2023" ( adobe)

 

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The collapse of the inflation rates is no surprise. I have been blogging about this topic since March ( driveby). Inflation follows the money supply (above the growth of money volume: M2 fred.stlouisfed).

 

 

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                      Helicopter Money

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 (buyers) enormous buying power. Friedman called this action prophetically helicopter money.

As a result in 2020 & 2021 the US money supply M2, the engine of the inflation, jumped 40%. 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. 

 

                            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 volume jumped. The flood of money raised suddenly the demand for scarce goods & services and caused a jump of the price level. I am convinced that the flood of monetary silver hiked the profits of many weavers, potters, bathers & traders in the 16th century.

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 evidence (charts above) shows that the up-and-downs of the inflation rates are following the monetary wave from 2020/21, confirming Copernicus & the monetarists from the 20th century.

If the Federal Reserve continues with her interest rate hikes - as already announced - it is likely that the inflation rates continue their sharp fall and turn negative. Maybe then the skeptics will have something new to worry about.