Economics: What Is Wrong With The Michigan 5-Year Inflation Expectations

(Drivebycuriosity) - If we believe the University of Michigan, in the next 5 years the US inflation rate will stay around 3%. This is the result of a poll, called "Michigan 5-Year Inflation Expectations" ( trading).

How can these people know what will happen in the next five years? Do they have any idea what caused the high inflation of the recent years? Apparently the so-called 5-year expectations are just an extrapolation of the recent trends.  

The image on top of the post shows that the variable went down before 2020, because inflation rates were very low, and then it went up again, following the rising inflation ( trading).

 

                         Uneducated Guess

 

 (source )

The polled expectations ignore that the reported inflation numbers are inflated by the "shelter costs", a mix of rents & house prices, which count for about 40% of the core-inflation and 27% of the headline inflation! In April 2024 inflation ex shelter was just 2.2%! ( bls.gov ). Unfortunately the statisticians calculate their "shelter costs" from rent payments from the past, therefore the "shelter" component has a time lag of 12-18 months! (marketwatch aier  cato). The actual reported inflation numbers are a view into the rear window.  

To make things worse, the poll is just an uneducated guess. It ignores the causes of inflation. In 2020 & 2021 the US government flooded the economy with stimulus checks in the value of trillions of dollars (American Rescue Plan), supported by massive 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 ).

As a result in 2020 & 2021 the US money supply M2, the engine of the inflation, jumped 40%. The money deluge met a constrained supply of goods & services partly - because of Covid19. "Inflation is caused by too much money chasing too few goods and services", noticed the economists at fisherinvestments".

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, 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).

 

 (fred.stlouisfed )

Fortunately the monetary growth has already peaked in February 2021 (with plus 27%). Since then the monetary growth rates have been falling and turned negative in December 2022 (image above). In the recent months the money supply has been shrinking!. 

The poll also ignores that the technological progress works against inflation because it reduces prices for many things, not just computers & smartphones. Internet, automation & other aspects of the technological progress are reducing the costs of producing & distributing stuff, curbing inflation. Therefore inflation was low before the money deluge of 2020/21 hiked the price level. But the money deluge is over.

The German poet and playwright Friedrich Schiller had an explanation for the stubbornly misguided "Michigan 5-Year Inflation Expectations":  "Against stupidity the very gods themselves contend in vain".