The “new thinking” that many prominent economists are employing to better understand what caused the 2021-2023 inflation has me flummoxed. Here’s why.
Proposition: When the central bank accommodates a burst of new government spending by purchasing Treasury bonds in the open market that the Treasury just sold in the primary market – or in less technical language, when the government pays for a burst of new spending with money hot off the printing press – inflation is sure to follow. A fundamental and everlasting economic truth, right?
Not any more, according to the new thinking on inflation. There was indeed a world in which an inflation of the 2021-2023 sort had only one possible cause: a stretch of time during which the quantity of money in circulation grows at a significantly greater rate than goods and services produced. Financial deregulation brought that world to an end 40 years ago. The innovations in banking and finance unleashed by deregulation have made it difficult to determine which assets count as money. Thus, the once clear relationship between money supply growth and inflation has disintegrated into no relationship at all.
So says the new thinking on inflation. Having dispensed with the idea that money might have something to do with money prices, economists of the new thinking have been identifying what might cause inflation in our new world of forty years and counting. Leading candidates thus far are supply chain disruptions, wage-price spirals stemming from a tight labor markets, and bursts of government spending, such as the $2.2 trillion CARES Act of 2020 and the $1.9 trillion American Rescue Plan (ARP) Act of 2021.
What has me flummoxed is the claim that money supply growth no longer shows any relationship to inflation. I made and checked the following calculations using money supply data from the Federal Reserve and consumer price index data from the Bureau of Labor Statistics. From 2000 to 2019, the U.S. money supply increased at an average annual rate of 6.2%. Over the same years, the average annual rate of inflation in the U.S. was 2.1%. The Federal Reserve’s aggressively expansionary policy ran from February 2020 through February 2022. From February 2020 to February 2021, the U.S. money supply increased by 26.6%, and from February 2021 to February 2022, by another 12.3%, which works out to a 42.2% money supply growth over the full February 2020 to February 2022 stretch. Inflation? The 12-month rate of inflation in the U.S. in January 2021 was 1.4%. In December 2021, inflation hit 7.2%; in June 2022; 9.0%.
Inflation has fallen considerably: the 12-month rate in July 2024 came in at 2.9%. The money supply has fallen, too – by 4.0% since March 2022.
The relationship between money supply growth and inflation is clear. I can see it without squinting.
Something else has me flummoxed. Monetary controversies have sparked a handful of intense debates about inflation’s causes that are famous in the history of economics. The lessons learned from those debates are worth remembering. Supply chain disruptions cause the prices of a narrow set of goods to increase. Inflation is when the prices of a broad range of goods increase persistently. A wage-price spiral is a symptom of inflation, not a cause. Without money supply growth, a wage-price spiral is impossible. Increases in government spending by themselves do not cause inflation. Every dollar the government spends comes out of someone else’s pocket, including the dollars the government borrows. That is, unless the central bank gets involved.
Forgetting directions and taking wrong turns will get a person lost. That happens in economics sometimes.
Reg Murphy Center