Tag Archives: M2 Money Supply

Persistent Inflation and Loss of Purchasing Power

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U.S. Consumer Price Index (CPI) data was hotter than expected.

March 2024 U.S.CPI annual inflation rose 3.5%, above expectations of 3.4%.

Core CPI inflation increased 3.8% year-over-year (Y/Y), compared to forecasts for a gain of 3.7%.

The March 2024 Consumer Price Index for All Urban Consumers (CPI-U) report marked a third consecutive 0.4% month-over-month (MoM) increase. On a year-over-year (YoY) basis, inflation rose by a stronger-than-expected 3.5% in March

  • The slightly stronger March Consumer Price Index (CPI) report was driven by rises in shelter and energy prices.
  • March’s stronger year-over-year (YoY) rise in the headline CPI suggests the path to the Fed’s 2% target could take longer than expected.

Persistent Inflation occurs when the U.S. money supply grows more rapidly (to pay for huge fiscal deficits) than the country’s economic output.

Money Supply and Inflation:

When the Federal Reserve (the Fed) increases the money supply, it leads to inflation.

Imagine an economy with $100 and 100 bananas. If the government increases the money supply by 10% to $110, but the banana output only grows by 5% to 105 bananas, we have more money chasing fewer goods. As a result, the average price per banana increases from $1 to roughly $1.05. Thus, the purchasing power of the currency is reduced.

The quantity theory of money (QTM) suggests that the value of money is determined by supply and demand. When the money supply grows faster than economic output, inflation occurs.

Monetarist View:

Monetarists believe that inflation results from too many dollars chasing too few goods. As the money supply grows, the value of money decreases due to supply and demand dynamics.

In summary, managing the money supply is imperative for the Fed. Too much growth can lead to persistent inflation, affecting the purchasing power of the dollar.

Looming Threat of Inflation

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“Inflation destroys savings, impedes planning, and discourages investment. That means less productivity and a lower standard of living.” Kevin Brady

Brian Wesbury, Chief Economist at First Trust Advisors, is concerned about inflation increasing faster than the Federal Reserve anticipates. Wesbury said that he is focused on the rapid increase in the M2 measure of the money supply. This measure has soared since COVID-19 hit the US, up about 25% from a year ago, the fastest growth on record.

From his viewpoint, the rapid increase in M2 is the key difference between the current situation and the situation in the aftermath of the Financial Crisis of 2008-09. During that first round of Quantitative Easing and big spending bills (like TARP), the M2 measure remained subdued because the Fed kept banks from lending, in part by raising capital standards. As a result, inflation remained subdued as well.

The late great economist Milton Friedman stress that policy makers watch M2: Nominal economic growth and inflation will tend to track M2 broadly over time, adjusted for any fluctuations in the velocity of money, the speed with which money circulates through the economy.

The US economy is healing faster than expected, while the US Congress and President Biden are intent on pouring at least one more massive government spending stimulus into the system, according to Wesbury. They are doing this even though the pandemic is waning, and a double-dip recession seems highly unlikely.

The big risk for the next couple of years is an upward surge in inflation that’s larger than anything we’ve experienced in the past couple of decades.

“I think the inflation prospects for the U.S. over the next five or six, seven years, are quite serious. You cannot have a bumper crop in apples without the value or the price of each apple falling. The Fed has had the largest increase in the monetary base in the history of the U.S., from colonial times to the present, times ten.” Arthur Laffer, an Economist known for his tax revenue theory called the Laffer Curve

He still project 2.5% CPI inflation for 2021, as the government’s measure of housing rents holds the top-line inflation number down. But commodity prices are likely to continue rising and overall inflation will as well in in 2022 and beyond. There is an old saying: When the Fed is not worried about inflation, Wesbury states, “the market should be worried.”

References:

  1.  https://www.ftportfolios.com/Commentary/EconomicResearch/2021/3/1/powell-disses-uncle-milty