Thursday, September 21, 2023

Economics: Is The Federal Reserve`s 2-Percent Inflation Target Really Too Ambitious?


 
(Drivebycuriosity) - Yesterday´s Fed declaration was a non-event. The Federal Reserve declared that they will hold her interest rates at the range of 5-1/4 to 5-1/2% as expected. The Federal Open Market Committee (FOMC) also declared that the Fed "is strongly committed to returning inflation to its 2 percent objective" (federalreserve ).

Some commentators call the 2-percent inflation target too ambitious. Some doubt it could be reached any time soon. I disagree. I believe that the still high inflation rates are just an aberration and that inflation will drop towards the very low rates we enjoyed before 2020 - maybe to zero (image on the top  source).

 

                      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).

 

                            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).

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 July M2 dropped 3.5% YoY ( fred.stlouisfed).

 

 


 (source )

Some commentator believe that rising oil prices will cause a return of high inflation rates. I disagree. I think that the recent oil rally will be short lived. Oil`s run is caused by multiple production cuts by Saudi Arabia which curb global oil production. Can the Saudis really keep oil expensive in the coming years? I doubt it.

Higher oil price will curb demand (demand destruction) again - as they did in the past - and also stimulate fracking & drilling in the US and other regions. Rising expenses for oil also absorb money which can not be used for purchasing other goods & services, curbing their prices, which will mitigate the influence of oil on the general price level.

 


 ( source)

The online prices are already falling. The software and service company Adobe reported that the online prices extended their deflationary trend (adobe ): "Online prices in August 2023 fell 3.2% year-over-year (YoY), hitting a 40-month low—and marking a full year (12 consecutive months) of YoY price decreases".

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.

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.  

Welcome to 2% inflation and lower.

No comments:

Post a Comment