Tuesday, August 19, 2008

Inflation Is a Clear and Present Danger? No Way

Data here for M2.

Data here for Base.

Brian Wesbury writes in today's WSJ article, "Inflation Is a Clear and Present Danger":

The most painful and frustrating economic policy blunder of the past 50 years was the Great Inflation of the 1970s. Painful, because it was the catalyst for three damaging recessions (1973-75, 1980, 1981-82), all the while eroding living standards and seriously undermining confidence in America.

It was also deeply frustrating. Despite the teaching of Milton Friedman -- which clearly explained that inflation was caused by too much money chasing too few goods -- a combination of bad economic models, denial and political expediency allowed it to happen.

Unfortunately, the lessons seem to be fading. Today, the U.S. (and through it the world) faces its greatest threat from inflation in 30 years. And as in the past, this threat is being met with denial and political expediency.

MP: Brian invokes Milton Friedman's monetarism to explain the inflationary 1970s, but then fails to apply it accurately to today's monetary aggregates (M2 and the monetary base, shown in the above charts), in my opinion.

Exhibit A: During the inflationary 1970s and early 1980s, M2 was growing at double-digit annual rates for much of the time, especially in the three periods circled in red in the top chart above during that period. There was a brief spike of 10% annual M2 growth during the 2001 recession and around 9-11, but M2 has been growing fairly moderately recently, in the 4-7% range for the last 5 years, suggesting that money growth is nowwhere near the double-digit levels required to replicate 1970s-era inflation.

Exhibit B: The monetary base, the "raw ingredient" of money supply and the one monetary aggregate that the Fed can control directly through its open market operations, has been on a contractionary trend since early 2002, almost 7 years ago. From 10% annual growth in early 2002, the growth of monetary base money has declined steadily, and has been around 2% since early 2007. In contrast, the monetary base was growing at around 10-12% annually in the inflationary 1970s.

Bottom Line: Invoking Friedman's monetarist theory (summarized as "inflation is always and everywhere a monetary phenomenon," and "inflation is caused by too much money chasing too few goods") clearly suggests to me that there just hasn't been large enough, recent enough increases in either: a) M2 or b) the monetary base, to fuel a return to the levels of inflation in the 1970s.

In other words, if inflation is a monetary phenomenon, where's the recent money growth that will cause it? It's just not there.


At 8/19/2008 9:06 AM, Blogger thomasblair said...

Here it is!


Or here!


At 8/19/2008 10:37 AM, Anonymous Anonymous said...

On Aug. 18, WSJ ran this article: Falling Commodity Prices Ease Fears of Inflation in Developing Countries.

It appears that we are past the high water mark on global commodity prices and that comparisons to the 1970s are overblown.

At 8/19/2008 10:49 AM, Anonymous Anonymous said...


I am a big fan of your blog but I think you are wrong on this issue. Check out top economic news of the day:

Producer Price Index Jumps 1.2%

At 8/19/2008 11:00 AM, Blogger Bob K said...

Inflation started in the 90's... but it wasn't consumer prices that got inflated, it was asset prices. Even smart economists seem to miss this. For whatever reasons, monetary velocity accelerated rapidly in the aftermath of the cold war.

Since the early 90's, we've seen a succession of asset bubbles, while trade and technology exerted downward pressure on consumer prices. First it was Internet stocks, then housing, secondary mortgages, Chinese stocks, gold, and oil.

This suggests that we're in a period of deflation, driven more by slowing velocity than the size of the money supply. Until the commodities broke down so severely, there was an inflation/deflation conundrum. Now the answer seems clearly to be deflation.

At 8/19/2008 11:37 AM, Blogger Doug said...

Maybe the government measures of money supply are wrong? Not sure why, but our government (even loosely including the Fed) has been known to make a mistake now and then.

When we see the price of so many commodies on the rise it is hard to doubt inflation is present.

Could it be that we are seeing inflation in some sectors and deflation in others and that is givig the impression things are on a more even keel?

BTW-love the blog and read it every day.

At 8/19/2008 1:02 PM, Blogger Caveat B said...

What about M3 growth? I know many folks think M3 is not meaningful compared to M2. On the other hand, I believe M3 growth is growing much faster than M2.

And shouldn't money supply growth be analyzed with the growth in the economy? If M2 grows at 7% per year but the economy is growing at 1% per year, doesn't that lead to a surplus of money and inflation?

At 8/19/2008 2:01 PM, Blogger thomasblair said...


Those two links I posted in the first comment show the growth of reconstructed M3, both long term (1970-) and short term (2004-)

M3 is growing at an annualized 15-16% right now.

At 8/19/2008 2:18 PM, Anonymous Anonymous said...


Interesting charts. Unfortunately, the source is not specified. How can we assess this information without knowing the source and the methodology?

At 8/19/2008 2:27 PM, Anonymous Anonymous said...

Well if we're talking about paper money, it has very little to do with my economy. All my income is transmitted electronically to my bank or broker, and transfers in or out of the accounts are either drafts or checks or via debit card or credit card. I hardly see any paper cash. Doesn't the unimagineable expansion of electronic trading have the same sort of impact as printing press money??? henryldepot

At 8/19/2008 2:28 PM, Blogger thomasblair said...


Chop off the end of the URL and you are left with:


Here is their info on reconstructed M3:


Other sources include this, but they have a subscription fee:


At 8/19/2008 2:53 PM, Anonymous Anonymous said...

Yes, finally I get to agree with Mr Perry! Mish has been making the deflation case most convincingly for a while. I suggest you read some of his posts

One warning: you should be reading Von Mises on money, not Milton Friedman. Friedman's prescription for preventing the Depression is nonsense. You need the purge in credit to return to normalcy. As John Stuart Mill said:
"Panics do not destroy capital; they merely reveal the extent to which it has been previously destroyed by its betrayal into hopelessly unproductive works."

I'm surprised I'm teaching this stuff to a free market economist though.

At 8/19/2008 9:12 PM, Anonymous Anonymous said...

Thanks for your comments on my article. However, your argument leaves a great deal to be desired. How can monetarybase growth slow for seven straight years without pushing inflation down? If you agree with Friedman, it should have caused a decline in inflation, but every measure of inflation is higher, not lower. Did you see the PPI today? Finished goods, intermediate goods, crude goods, all of them, whether "core," or not, are up signficantly from seven years ago.

Brian Wesbury

At 8/20/2008 6:26 PM, Blogger Mark J. Perry said...

See my response to Brian Wesbury in a new post.

At 8/23/2008 2:14 PM, Anonymous Anonymous said...

Perhaps inflation is related to government waste (spending):


from article:

from website:

At 11/09/2008 1:54 PM, Anonymous Anonymous said...

Brian Wesbury is a fool and constantly wrong about his future economic projections.

At 2/22/2009 1:15 PM, Anonymous Anonymous said...

Kudos to Bob K...he got it right and is right. Wesbury is terrible, just like Kudlow and Abby Cohen. They only look backward...anyone can do that. A good economist can look forward.


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