Saturday, August 15, 2009

Inflation Fears? Let's Check the Historical Record

There are some economists who are concerned about future inflation because of the loose, expansionary monetary policy in 2008, e.g. see Brian Wesbury and Bob Stein here, here and here. I don't think inflation will be a problem, and here's why:

The chart above shows the annual growth rate in the M2 money supply (percent change from the same month in the previous year, data here) monthly from January 1960 to July 2009. Notice that:

1. There was sustained double-digit money growth in two periods in the 1970s, and that is what generated the high double-digit inflation in that decade. There was double-digit M2 growth for 29 consecutive months from March 1971 to July 1973 (and nine straight months above 13%), and then again for 30 consecutive months from July 1975 to December 1977, with a high of almost 14% growth in early 1972 (see chart above).

2. There was double-digit M2 growth in 1983, but only for 12 months from January to December of 1983, and this monetary expansion wasn't enough to cause inflation (see chart below). Inflation never rose above 5% for many years after the double-digit money growth of 1983.

3. There was double-digit money growth in September, November and December of 2001, but inflation in subsequent years never got above 5% (see chart below).

4. The peak monetary expansion of M2 in 2008 was below the peaks in 1971-1972, 1976-1977, 1983 and 2001 (see chart above), and during the recent monetary expansion there has been only one month of double-digit money growth, and that was the peak of 10% in January 2009.

Bottom Line: Without sustained double-digit M2 growth, we won't have anything close to double-digit inflation. And the historical evidence during the two most recent experiences of double-digit money growth in 1983 and 2001 demonstrates that short periods of double-digit money growth aren't enough to bring about inflationary pressures. And since recent M2 growth during the "loose" monetary policy of 2008 is actually lower than in 1983 and 2001, there probably can't be any inflationary pressures that will lead to problems with future inflation. In other words, a single month of double-digit M2 growth in January 2009 isn't expansionary enough to create inflation.

Originally posted at Carpe Diem, not to be re-posted at Death and Taxes without permission.


At 8/15/2009 3:12 PM, Anonymous Anonymous said...

We no longer have a trickle down economy. We have a bubble up economy. The Fed is trying to re-bubble the markets with low rates. Get the bubble in real estate, commodities and stocks going again and everything will be wonderful. Coupled with unprecedented fiscal stimulus, the next collapse could be even worse than this one.

The question is, is the misallocation of capital and frenzied speculative activites encouraged by a distirted tax policy and funded with artificially low interest rates good for the economy?

At 8/15/2009 5:27 PM, Blogger Bloggin' Brewskie said...

Recalling your predictions from early in the year, when you predicted mid-summer as the time the recession would bottom out, I have to say I must congratulate your efforts to bring sense and rationality to an era of economic uncertainty.

While not everything posted can be agreed upon, this blog is never boring.

At 8/15/2009 5:48 PM, Anonymous Dr. T said...

Dr. Perry, I think you are missing the real concern. Historical inflation trends based on money supply growth mean nothing when Obama can order the Treasury Departmeent to print half a trillion dollars in new bills whenever the urge strikes. That's the inflation I'm worried about.

At 8/15/2009 5:52 PM, Blogger Mark J. Perry said...

Dr. T: Inflation is caused by excessive growth in the money supply, which is controlled by the Federal Reserve. Obama has no direct control over the money supply or the Federal Reserve. When the Treasury issues debt, that is completely separate and different. When the Treasury issues debt, it has NO effect on the money supply, and therefore no effect on inflation.

Inflation is always and everywhere a monetary phenomenon, and since the Fed has control over the money supply, only they can cause inflation.

Bottom Line: Obama has no conrol over the money supply, and therefore he cannot cause inflation.

At 8/15/2009 7:55 PM, Blogger Bill said...

Dr. Perry,

I very much enjoy reading your posts and hope very much that we will have good growth and low inflation in the year ahead, but I do worry that things are different this time with all the instant "analysis" from the media which change their predictions about the economy on day to day basis based on the chart of the day. Do you think there is some risk that the consumer (and hence the economy) will hold back because of the confusion about where the economy is headed in the media?

At 8/15/2009 9:01 PM, Blogger PeakTrader said...

"Inflation is always and everywhere a monetary phenomenon" is true only in the long-run, because of shifts in the foreign exchange market or changes in the velocity of money in the short-run. It should be noted, monetary policy prevented a deep depression in the 1970s, similar to the 1870s and 1930s (there were several recessions from 1970-82, including two severe recessions).

Also, many shocks take place, e.g. Y2K (when the money supply spiked higher and then lower around 2000), 9-11, an oil shock (or commodities in general), minor technology shocks in the '80s and '90s, and the quick and massive
"Creative-Destruction" process in the early '00s.

Economies are often too dynamic to accurately predict. I expected China's economy to collapse, along with other major net export countries. China was showing production strains, including cutting corners exporting unsafe products, received increasingly smaller gains of trade, and had enormous social costs. However, the U.S. economy, along with the Republican party, imploded instead.

U.S. households didn't get much of a bailout. Instead, they were burdened with even more debt from massive government spending. It's uncertain how that will play out, e.g. Americans working harder and longer to pay-down debt, adding to future economic growth, or consume less to strengthen their balance sheets, leading to slower economic growth.

At 8/15/2009 10:54 PM, Anonymous gettingrational said...

What if the Fed declares a steady increase in the supply of money for the next two years? Will the this result in steady growth in the U.S. economy? Let the administration build their policies based uopn the known future increase in the money supply. The size of the M increase should be defined by the Fed and not dictated to the Fed by the White House. I think Milton F. would heartily approve if he were around.

At 8/16/2009 11:53 PM, Anonymous said...

Just for the record, in December 2007 I interviewed Mark about his inflation forecast ( At the time of the interview, the CPI had risen 4.2 percent in a 12-month period. Mark was quite optimistic about inflation in 2008. Actual results: - 0.1 percent, for a very good forecast.


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