economics

Post-COVID, A Large Increase in Inflation May Be Coming

Economist, Political Analyst
Economist, University of Buckingham
Genesis
Response
Penultimate
Finale

Tim Congdon

Economist, University of Buckingham

May 21st, 2020
One problem with standard monetary theory – which emphasizes that the value of money falls if too much of it is created – is the ambiguity of the notion of “money”. We need to use the right concept of “the quantity of money” if we are understand how excess money growth causes inflation.
Spending on goods and services – which of course affects their prices – is carried out mostly by non-bank agents, such as households and companies. It follows that the quantity of money relevant to the determination of price level movements must be one that includes money balances held by such non-bank agents. Nowadays the great majority of these balances are bank deposits. I have argued in a large body of work – in the tradition of Friedman and Schwartz’s classic 1963 study A Monetary History of the United States 1867-1960 – that the key money aggregate includes all bank deposits, including time deposits. (See, for example, a chapter in a 2017 collection edited by me on Money in the Great Recession.) Monetary economists squabble about these matters, but my own focus in the context of the United States has been and remains on the broadly-defined M3 measure.
Macario Schettino has a different approach. He believes that a crucial influence on macroeconomic outcomes comes from the central bank balance sheet and, specifically, from “the monetary base”. The monetary base contains notes and coin held by the general public, and – in the US case – banks’ cash reserves at the Federal Reserve. I totally reject this view. Yes, non-bank agents do use notes and coin for some of their transactions, but nowadays their value is less than 1 per cent of total transactions. Of course, cash reserves are held by banks, not by non-banks, and I have just explained why I am not interested in them. Banks’ own purchases of goods and services are tiny – perhaps 2 per cent – of aggregate demand.
Professor Schettino wonders why rapid inflation did not follow the Fed’s asset purchases, and the associated ballooning of its balance sheet, in the five years from late 2008. The answer is that M3 growth in that five-year period was still very weak. (Indeed, a chart shows that M3 actually declined for some months in 2009 and 2010.) By contrast, M3 growth has accelerated markedly since 2018. In 2019 this acceleration was mild, from an annual rate of 4% or so which had been common for most of the 2010s, to over 8% at year-end. In 2020 the continued acceleration has been astonishing. In the last 12 weeks bank deposits at US commercial banks have grown by almost 14%, or by over 1% a week. If this carried on for a year, the quantity of money would rise by about 75%, a truly Latin American rate of monetary expansion. The USA is heading for a large increase in inflation.
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