The benefit of every government report on inflation is to remind us how even intelligent people are often confused—even if they may have once been acquainted with the economic way of thinking. I read in today’s Wall Street Journal (“Inflation Slipped in April, but Upward Pressures Remain,” May 11, 2022):
Those dynamics are pushing up wage gains—adding multiple pressures on inflation. Some employers are raising prices to offset higher labor costs. Strong wage growth and hiring are also simply putting more income in Americans’ pockets.
How can the reader untie this Gordian knot? Here is the obvious interpretation: Past inflation has led to higher wages, which lead to more price increases (more inflation) which, combined with higher consumer incomes due to higher wages, will generate more inflation. Why wouldn’t the cycle repeat? How can inflation, once begun, ever be stopped or even reduced? We are not told. But it is suggested that only the mysterious and powerful hand of government can stop it. But then, why didn’t the government’s powerful hand stop inflation before or prevent it from starting in the first place?
The idea that inflation or at least its persistence can only be caused by government creating money seems to have been forgotten if it ever was learned. The figures below from John C. Frain, reproduced from a previous post of mine, may serve to illustrate; the second figure eliminates the two top outliers of the first one. The correlation between the money stock (although an admittedly imperfect measure of the money supply) is striking.
READER COMMENTS
Grand Rapids Mike
May 11 2022 at 6:18pm
Read or heard somewhere that 1,000 or more PhD economist work for the Federal Reserve. Yud think one of these could have reminded Powell of this equation. It also points to the possible effect of M. Friedman not being around. If he were here, he would have constantly reminded the gang at the Fed of there folly of hyper expanding the money supply. On the other hand the woke culture could have dismissed him as just being racist.
Daniel Kian Mc Kiernan
May 11 2022 at 8:35pm
Nancy MacLean followed-up her hatchet-job on Buchanan with a hatchet-job on Friedman, claiming that he began advocating school-choice to reëstablish segregation in the wake of Brown v. Board of Education.
Craig
May 11 2022 at 8:37pm
They know. They chose inflation, I honestly think they felt they got away with QE the last time that they’d give it another go and hope the inflation didn’t appear again.
Here’s the rub, when the inflation did appear, Powell and the Fed at THAT point, its just straight up propaganda at that point.
The pandemic hit, the government shut the economy down AND promised that it would make good the income losses and did so by financing that through money creation. My 11 year old son told me today that sounds inflationary to him, you know and he’s just in the 5th grade.
Warren Platts
May 12 2022 at 1:43am
I think maybe the difference between the Great Recession & the pandemic is that during the GR, most of the QE money got funneled through the banking system that had just got burned by a wave of loan defaults. So they basically hoarded the money by radically reducing the number of loans they were making. Thus since MV = PQ, although M increased, V actually declined thus there was little pressure on price levels.
In contrast, during the pandemic, the money supply increased, but a lot of it was sent directly to consumers in the form of “stimmy checks.” Thus M increased and maybe V increased, but Q is flat to down, then you got a lot of pressure on price levels P.
Here’s the rub, when the inflation did appear, Powell and the Fed at THAT point, its just straight up propaganda at that point.
That’s kind of funny. I was 11 in 1974 and having similar thoughts!
Jon Murphy
May 12 2022 at 7:35am
It’s not a velocity story as velocity collapsed in 2020 and hasn’t picked back up. I think it’s simply an M story, with some Y. M has rapidly increased and no change in V. Y shrank and is largely inelastic (due to a number of reasons including, but not limited to, Trump’s tariffs, the Defense Production Act, Jones Act restrictions, de facto labor restrictions) So, the only where for things to go is P.
Matthias
May 13 2022 at 8:21am
In the aftermath of 2008 the Fed largely sterilised their QE via interest on excess reserves.
They didn’t do that this time.
Craig
May 13 2022 at 12:01pm
At the end of the day though if the Fed is sitting on a treasury, that money makes its way to the government and is spent on all things governments spend money on, whether it was the stimulus or Medicaid or defense. I’d suggest that QE made inflation higher than it would’ve been without the QE, but if we take a peek at some broader measures of the money supply, ie Divisia M3/M4 as measured by the Center for Financial Responsibility we can see many months with negative money creation in the face of QE.
Compare that era with the post-pandemic era and the difference is really stark.
Daniel Kian Mc Kiernan
May 11 2022 at 8:23pm
General price-inflation simply cannot be a result of producers (of labor or of other commodities) seeking higher prices.
Necessarily,
M⋅ν = Σ(pₐ⋅qₐ)
where M is the amount of money used in transactions, ν is the average frequency with which the monetary unit changes hands, pₐ is the price of the ath commodity, and qₐ is time-rate at which quantities of that commodity are exchanged. As the cost of moving money increases at an increasing rate as ν is increased, ν does not increase indefinitely.
Ahmed Fares
May 11 2022 at 8:28pm
The idea that inflation or at least its persistence can only be caused by government creating money seems to have been forgotten if it ever was learned.
It also happens to be wrong. Inflation causes money printing and not the other way around.
Yes, that is true; Henwood adopts the Monetarist explanation that “too much money” causes inflation. He confuses causation and correlation. Severe supply constraints can push up prices, increasing the amount of money that needs to be created both publicly and privately to finance purchases. Tax revenues fall behind spending so a deficit opens up as spending tries to keep pace with inflation. The money stock is a residual and it will grow rapidly with hyperinflation. That does not mean it is the cause. Mitchell has closely examined the hyperinflation cases from the MMT perspective; the argument is not at all odd and has the advantage that it is fact-based, unlike Henwood’s Monetarist linking of money and inflation that has been so thoroughly discredited that even central bankers have dropped it.
source: Response to Doug Henwood’s Trolling in Jacobin by L. Randall Wray
http://neweconomicperspectives.org/2019/02/response-to-doug-henwoods-trolling-in-jacobin.html
Jon Murphy
May 12 2022 at 9:57am
That story cannot explain what we are currently witnessing. The money supply rapidly expanded in 2020. Inflation didn’t set in until 2021. Inflation could not have caused the current bout of money printing.
robc
May 12 2022 at 11:48am
Don’t even bother, he lives in MMT-town.
Dylan
May 12 2022 at 6:50pm
Jon, certainly you’re not so limited in your thinking to think that cause must always precede effect?
Jon Murphy
May 12 2022 at 7:12pm
Man, I am having flashbacks to high school: Everything is going well and then physics comes along to ruin it.
Jose Pablo
May 13 2022 at 11:27am
Dylan, you are not suggesting FED officials should attend quantum mechanics courses, aren’t you?
Maybe is a punishment they deserved, but it is just too cruel.
Pierre Lemieux
May 13 2022 at 3:01pm
Jose: Reading Dylan and Jon, I also thought about quantum physics. Perhaps in the afterlife, where there is no scarcity (assuming nobody misses his previous universe full of wet life and carbon emissions), quantum economics will developed.
Ahmed Fares
May 11 2022 at 8:33pm
Well, it looks like my nicely formatted comment above with italics and spacing got all screwed up and got posted as one large blob. Sorry about that.
vince
May 13 2022 at 9:10pm
Ahmed, the Econolib formatting is awkward. I wish one could see a preview before submitting.
Anyway, you said inflation causes money printing, quoting: Severe supply constraints can push up prices, increasing the amount of money that needs to be created both publicly and privately to finance purchases.
Yes, supply constraints push up prices. Constraints mean shortages. Shortages mean you can’t buy as much. Now, if I were a counterfeiter, I would start printing money so I could be first in line, stealing through counterfeiting, and let someone else suffer from the shortages.
So the quote should instead say: Severe supply constraints can push up prices, increasing the amount of money that needs to be created–BY GOVERNMENT-LED THEFT–both publicly and privately to finance purchases.
Craig
May 11 2022 at 9:27pm
“The idea that inflation or at least its persistence can only be caused by government creating money seems to have been forgotten if it ever was learned.”
If a politician raised taxes he or she will likely pay some kind of political price. Deficit spending, putting the cost on the future generation becomes expedient. I don’t know, would the government had found willing buyers for the bonds during the pandemic when QE was covering 90%+ of issuance? Couldn’t tell you, but if you perceive at least that you can’t borrow what a fantastic tax, tax buying power and blame greedy capitalists and everybody’s least favorite Russian dictator.
Craig
May 11 2022 at 9:59pm
At the end of the day the government would be in an untenable position if it came out and said, “QE is causing inflation, we know its causing inflation of 8%+ Y/Y, and btw we’re going to continue doing it anyway, but please buy a treasury yielding under 2%.
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