Economics: Why Inflation Is Cooling

  (Drivebycuriosity) - Today we learned that the US inflation rate sank to 2.5% continuing the slow retreat of the recent months (cnbc ). That was not a surprise.

 

                         Helicopter Money

The high inflation of the recent years was caused by a deluge of money in the years 2020 & 2021, when the Biden government flooded the economy with stimulus checks in the value of trillions of dollars to fight the Covid19 recession (American Rescue Plan). The Federal Reserve financed the government checks by massive bond purchases by the Federal Reserve (Quantitative Easing known as QE1, QE2 & QE3).  

The government money landed directly on the bank accounts of the Americans, blowing up the money supply M2 (bank notes & coins & deposits at banks). Milton Friedman described this as helicopter money (cato ).

 

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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", taught Milton Friedman.

                        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, 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 The Money

 

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Fortunately the money flood ended in 2022 and the money supply shrank for a while. Since October 2023 the money volume is growing again, but only moderately. 

Since inflation follows the growth of money, the inflation rate (growth rate of prices) will follow the pull of the slow growing money supply and the inflation rate will continue to cool.