Saturday, December 15, 2007

Why Inflation Will NOT Be A Problem

Inflation vs. M1 Growth with a 3-year Lag
The top chart above (click to enlarge) shows the relationship between M1 Money Supply and the effective Fed Funds rate from 1999-2007. Notice that there was a 25% increase in M1 that was required to get the Fed Funds rate to fall from 6.5% in 2000 to 1%. The bottom chart shows that M1 grew between 3.5% and 6.5% in each year from 2001-2004.

The bottom chart allows for a 3-year lag between growth in the money supply and its eventual full effect on the price level and inflation (average annual inflation), and therefore matches M1 growth in 1998 with consumer inflation in 2001, etc.

November 2006-November 2007 inflation was 4.29%, and inflation averaged 2.72% for the year to date, reflecting the strong money growth in 2004 of 5.58% (allowing for a 3-year lag). The good news on the inflation front is that inflation in 2008 will reflect money growth in 2005 (assuming a 3-year lag), which was less than half (2.05%) of money growth in 2004 (5.58%).

Bottom Line: Inflation will not be a problem in the future, and will likely fall in 2008 and 2009 from its level in 2007. The money supply has been flat now for 3 years, suggesting that inflation in the future will be low and stable. The money supply (M1) has actually FALLEN over the last year.


At 12/15/2007 10:12 AM, Anonymous Anonymous said...

Jim Puplava has an excellent article with some great graphs on how and why the published inflation rate is manipulated.

Tim LaFleur is a commodity specialist for televisions at the BLS. In December last year he adjusted the price of a 27-inch television set for quality improvements. The 27-inch television set had a retail cost of $329.99. However, he decided the new model, which still sold for $329.99, had a better screen. After putting this improvement through the governments complex hedonic adjustment model he determined the improvement in the picture was worth at least $135! Taking in this improvement he adjusted the price of the TV by $135, concluding that the price of the TV had actually fallen by 29%! [1] The price reflected in the CPI was not the actual retail store cost of $329.99, but $194.99. The only problem for we consumers is that if we went to Best Buy or Circuit City to buy that TV, we would still pay $329.99.

You are right in that the published inflation rate will not be a problem.

However the real inflation rate will be a problem to the real consumer spending real dollars.

Real consumers do not have the option of giving Best Buy $194.99 for a TV priced at $329.99.

At 12/15/2007 10:12 AM, Anonymous Anonymous said...

It has always been my argument that there can be no inflation with money supply flat to declining and velocity declining. However, in Friday's WSJ op-ed there was an interesting argument that the rise of the non-bank banks has in fact increased money supply just not the traditional scoring of that increase. Your thoughts?

At 12/15/2007 12:50 PM, Anonymous Anonymous said...

The European hyperinflations ended BEFORE money growth was reduced, and the same happened to US inflation in the mid 1980's. Careful observers have concluded that the quantity theory of money does not correctly describe the relation between money and prices. It's therefore possible that inflation can pick up before the money supply does.

More at:


Post a Comment

<< Home