Tuesday, August 12, 2025

Economy: Why Doesn`t Inflation Get Hotter In Spite Of Trade War & Rising Tariffs?


 (Drivebycuriosity) - There is a lot ado about President`s Trump`s trade war and the tariff hikes. Rightly so, his tariffs do a lot damage. But inflation stays tame. In July the price level rose just 2.7% y-o-y (image above cnbc ). 

Tariffs do not create inflation! They hike the prices of imported goods and goods from producers who compete with foreign producers. But other prices, like houses, dentist visits, cinema admissions and many others, are not touched. Economists talk about relative prices, contrary to the general price level.

Milton Friedman said "inflation is always and everywhere a monetary phenomenon". He was right. The money volume, the amount of money available in the whole economy, restricts how much people can spend. If they have to pay higher prices for imported goods, then they purchase fewer of them or they spend less for other goods & services.

The recent high inflation was caused by a deluge of money in the years 2020 & 2021. In 2020 & 2021 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 government checks got financed with 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 volume M2 (bank notes & coins & deposits at banks). Milton Friedman described this as helicopter money (cato ). As a result in 2021 & 2022 the US money supply M2, the engine of the inflation, jumped 40%. Unfortunately the money deluge met a constrained supply of goods & services partly - partly because of Covid19. So the price level inevitably had to jump and the inflation rate (first derivation) went up.

 

                         Causal Relationship

The causal relationship between the money supply and inflation was already recognized by Nicolaus Copernicus! The astronomer explained in the year 1517 why "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 it was printed into coins and used as money.

As a result the European money supply jumped, but the supply of goods & services did not change much. 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) confirmed Copernicus & the quantity theory of money. They described in the 1960s elaborately how and why the inflation rate follows the growth rate of money with a time lag (causal connection).



 ( source)

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