Economics: Why The Inflation Fears Are Overblown

(Drivebycuriosity) - There is a lot ado about inflation. The Iran war pushed oil prices higher and amplified the price jumps caused by the tariff hikes. But I suppose that both influences are just temporary and the inflation hike will teeter out.

                  Helicopter Money 

We learned from Milton Friedman that "inflation is always and everywhere a monetary phenomenon". The money volume, the amount of money available in the whole economy, restricts how much people can spend for goods & services. If they - for in instance - pay higher prices for imported goods, then they purchase fewer of them or they spend less for other goods & services.

Friedman`s insight got confirmed by the recent inflation wave. It was caused by a deluge of money in the years 2020 & 2021. In 2020 & 2021 the 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).
 

 

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But the money deluge has ended. Today the US inflation is constrained by the slowly growing US money supply. In the recent months M2, the engine of inflation, grew just 4.7%. Simultaneously the US economy, represented by the GDP, advanced 1.6%. There is not much space for price hikes and inflation will run out of fuel.