Persistent inflation is a monetary phenomenon always and everywhere

Milton Friedman famously claimed that inflation is always and everywhere a monetary phenomenon. He later clarified that he was referring to its episodes Continuously Inflation In the short run, supply shocks can affect the price level.

Over the past decade, I’ve argued that trend RGDP growth has fallen to around 1.5%, mostly due to slower labor force growth (retiring boomers and fewer immigrants.) In that case, the Fed would need to generate around 3.5% NGDP growth to maintain its 2% inflation target. to keep

The new GDP figures show a steep rise in nominal spending, with NGDP growing at over 6.7% annually. (Please wake me up when the Fed starts its tight monetary policy.)

NGDP has grown 19.2% over the past three years, whereas 10.9% growth would have been appropriate if the Fed had been serious about maintaining an average inflation rate of 2%. 100% of the extra 8% nominal GDP growth is due to an overly expansionary monetary policy. Monetary policy cannot control aggregate supply, but it can control nominal spending.

This leads me to investigate how much of the inflation problem is due to monetary policy and how much is due to supply shocks. By the end of 2021, part of the inflation problem was clearly due to supply problems. But how about today?

The most recent PCE inflation figures are for August 2022, and the price level has risen 14% over the past three years. Note that prices rose 8 percentage points more than the 2% annual inflation target (which would be slightly above 6% in three years.) This equates to additional NGDP growth. As of today, it’s all in demand.

Friedman was right that persistent inflation is almost 100% a monetary phenomenon. But he was not right about the best way to identify a “financial phenomenon”. Friedman focused on growth in monetary aggregates, whereas many of us now believe that it is NGDP that best measures the stance of monetary policy.

Just as in the 1970s, demand-side inflation has been mistaken for supply-side inflation. In the short run, supply shocks may actually cause inflation to deviate from NGDP growth. But in the long run, inflation is driven almost entirely by aggregate demand, that is, by growth in nominal spending.

It’s NGDP, stupid.

Rest assured. In fairness to Friedman, the M2 money supply has grown 41.6% over the past three years. So while not all inflation is due to rapid money growth, it is. In fact the velocity has actually slowed during this period, meaning that over 100% of inflation comes from monetary policy as defined by Friedman. So, at least this time:

It’s money supply, stupid.

PPS. A few months ago I criticized Robert Barrow claims That we can be “highly confident” that the US has entered a recession as early as 2022. Today’s data effectively eliminates that possibility. (Something we already knew from many other indicators.) We may soon enter a recession (they’re hard to predict), but we’re almost certainly not in one until early 2022. Please re-read my previous post to find out why Barrow made a mistake.

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