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Is “Inflation…always and everywhere a monetary phenomenon”?

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Milton Friedman famously said that:

Inflation is always and everywhere a monetary phenomenon…

But that doesn’t seem to be the case recently:

The blue line is the annual percent change in M1, the green line is the annual percent change in M2, and the red line is the annual percent change in the CPI, or inflation. Inflation has remained muted while the money supply has increased dramatically over the last 4 years. The correlation between the percent change in M1 and the CPI is -0.48 and between M2 and the CPI is -0.19. Nonetheless, monetarists tell us to worry about inflation.

But is this really what Friedman meant? I don’t know, but Wikiquote gives us a more complete quote than I’ve given above:

Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.

So what he seems to be saying is what seems to be the obvious truth that you can’t have inflation without an increase in the money supply. What he isn’t saying, at least in this quote, is that you will always get inflation with a large increase in the money supply. After all, if the money is not spent, then the price level won’t go up. And that seems to be the case recently. People and (especially) firms are hoarding money, mainly in the form of checking accounts, but also a bit in the form of currency. When they start spending again, the Fed is going to have to do some quick work to avoid inflation, but it certainly won’t be impossible.

Maybe I’m missing something obvious. After all, I’m not a monetary economist. But it seems to be like inflation is mainly caused by higher aggregate demand (along with things like indexation). It can be controlled by tightening monetary policy, but it can’t be produced by simply increasing the money supply.

That’s why I don’t really get the whole NGDP targeting argument. The argument, as I understand it, says that when real GDP growth is lower than the Fed would like, it should accept higher inflation. But low AD leads to lower inflation. How is the Fed supposed to get to 5% inflation in today’s economy? The money supply (M1) has increased by over 50% since 2007 and inflation has stayed well below 5%! What is the Fed supposed to do?

Really, I’m asking.

Written by Liam C Malloy

April 19, 2012 at 1:13 pm

Posted in Uncategorized