Is There A Simple Connection Between Monetary Aggregates and Prices?
I think we are in store for massive yr/yr price inflation (where 8% < massive < 100%) within the next 6 - 12 months. My reasons are qualitative: (1) Bernanke is terrified of deflation and has allowed the base to grow like crazy, (2) real output is going to tank, and (3) once the panic has subsided and people calmly consider what the US government has done in the past few months, the dollar will get crushed in the foreign exchanges. Now I can’t really give much more specific predictions than that, because I still haven’t found a model (or “framework” if the word “model” scares you) for empirically handling these issues with which I’m comfortable. For example a monetarist might like Friedman’s idea of looking at the quantity of money per unit of real GDP. You’d think that if you could predict those two things, then you could predict (price) inflation. But no you can’t, because the demand for money could change. During the 1970s, the graph of the quantity of money (measured as M1, say) divided by real output, tracks the CPI pretty well. But during the 1980s it breaks down completely. M1 per unit of real GDP goes way up, even though price inflation was very modest. The answer (according to Arthur Laffer, and I agree with him) is that the Reagan tax cuts and other pro-business moves made US assets more attractive, and increased the demand for dollars. (I think also the disinflation might have caused a feedback effect too, where lower inflation expectations are partly a self-fulfilling prophecy, though I don’t know if Laffer would endorse that angle.) Now even though he is possibly my favorite blogger right now, even so I think Robert Wenzel has oversimplified the analysis in a recent post, where he said:
Stop Printing Money….like the Fed did this summer and you kill inflation.
Wholesale prices plunged a record amount in October.
The Labor Department reported today that wholesale prices dropped by 2.8 percent in October, the biggest one-month decline on records that go back more than 60 years.
The 2.8 percent overall decrease marked the third straight month that wholesale prices have fallen.
Money supply growth, as measured by M2 nsa, was under 2% on an [annualized] basis this summer, but is now back up over 7%. Take advantage of the inflation pause while it lasts by buying hard assets.
Wenzel’s analysis might be fine as far as it goes, and I agree that people should buy gold right now if they haven’t already. But if Wenzel is saying that M2 growth is a reliable harbinger of price inflation, then I think he is wrong. (If he wants to clarify in the comments I will gladly post a correction here if I am misrepresenting his view.)
The chart below plots annual percentage changes in M2 against annual percentage changes in the CPI. If anything, the two almost seem to move inversely. If I had a crystal ball and knew the monthly M2 figures out till 2020, I’m not sure I could make much money from that information. (Then again, with my PhD in economics, you could probably tell me the weekly share price of Exxon out till 2020, and I wouldn’t be able to profit from it…)
