The inflationary consequences of the broad money supply surge in 2020 : a monetarist approach
Viitanen, Tom (2022)
Viitanen, Tom
2022
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Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi-fe2022051134778
https://urn.fi/URN:NBN:fi-fe2022051134778
Tiivistelmä
In the fourth quarter of 2021, the inflation rate in the US was 7.0%, measured with the implicit GDP deflator, a number above the Federal Reserve’s 2% inflation target. The Fed and many leading economists could not foresee the growth in inflation that started in 2021 and blamed the inflation on transitory supply-chain problems. However, some economists who applied the quantity theory of money and considered the long and variable lags associated with broad money growth and inflation were able to predict the high levels of inflation in 2021. Cumulatively, the M2 measure of money increased by 40.52% between Q1 2019 and Q4 2021 due to the pandemic-related monetary policy actions. Currently, the Federal Reserve and many mainstream economists ignore monetary aggregates in their models, hence, risking not extracting any valuable information value provided by the money measures. Inflation erodes peoples’ purchasing power, risks social unrest, postpones investment decisions, and misallocates resources when the price system becomes distorted. The poorest in society are hurt the most, since they lack such negotiation power and resources that those who are better off tend to have. Hence, a central bank needs to maintain price stability.
This thesis applies the P-star model, which has its origins in the quantity theory of money, to estimate the US price gap and, hence, estimate the average annual inflation rates for the next 3 to 4 years starting from 2022. The P-star model assumes that the current price level will move towards equilibrium. The main critique against the quantity theory of money relates to the instability of money velocity; hence, two alternative scenarios will be investigated to test the robustness of the main results. Additionally, this thesis will try to determine if the Federal Reserve should start to extract information from the monetary aggregates. Also, because the Federal Reserve and the mainstream economists view the economy through interest rates and not money, the original Taylor rule will be estimated to see where the federal funds rate should be when the inflation rates are high.
This thesis finds that the US price gap in Q4 2021 is 25.09%, implying an average annual growth rate of the implicit GDP deflator to be in the range of 6.27% to 8.36% for 3-4 years starting from 2022. The alternative scenarios, which are considered less likely, imply a price gap of 12.58% and 37.60% in a good and bad scenario, respectively. In the main scenario, it is assumed that the M2 equilibrium velocity is 1.41, compared to the actual level of 1.12, which is below the equilibrium value due to Covid-19 restrictions. In the good and the bad scenarios, the equilibrium velocity is assumed to be 1.27 and 1.55, respectively. It is also found that the monetary aggregates contain information value that the Federal Reserve should not ignore. The original Taylor rule implies that in Q4 2021, the federal funds rate should be 11.27% compared to the actual federal funds rate of 0.08%. This thesis recommends that the Federal Reserve slows the growth rate of money to a level consistent with the M2 golden growth rate of 5.24-5.99%, whereas the year-over-year growth rate in Q4 2021 was 13.07%. Slowing the growth rate of broad money is the only way to cure the inflation disease, and as a consequence of money growth slowing, a recession will follow. It is crucial that the Fed stays the course and does not endanger the healing process by accommodating more excessive broad money growth; otherwise, the inflation problem will worsen and last longer.
This thesis applies the P-star model, which has its origins in the quantity theory of money, to estimate the US price gap and, hence, estimate the average annual inflation rates for the next 3 to 4 years starting from 2022. The P-star model assumes that the current price level will move towards equilibrium. The main critique against the quantity theory of money relates to the instability of money velocity; hence, two alternative scenarios will be investigated to test the robustness of the main results. Additionally, this thesis will try to determine if the Federal Reserve should start to extract information from the monetary aggregates. Also, because the Federal Reserve and the mainstream economists view the economy through interest rates and not money, the original Taylor rule will be estimated to see where the federal funds rate should be when the inflation rates are high.
This thesis finds that the US price gap in Q4 2021 is 25.09%, implying an average annual growth rate of the implicit GDP deflator to be in the range of 6.27% to 8.36% for 3-4 years starting from 2022. The alternative scenarios, which are considered less likely, imply a price gap of 12.58% and 37.60% in a good and bad scenario, respectively. In the main scenario, it is assumed that the M2 equilibrium velocity is 1.41, compared to the actual level of 1.12, which is below the equilibrium value due to Covid-19 restrictions. In the good and the bad scenarios, the equilibrium velocity is assumed to be 1.27 and 1.55, respectively. It is also found that the monetary aggregates contain information value that the Federal Reserve should not ignore. The original Taylor rule implies that in Q4 2021, the federal funds rate should be 11.27% compared to the actual federal funds rate of 0.08%. This thesis recommends that the Federal Reserve slows the growth rate of money to a level consistent with the M2 golden growth rate of 5.24-5.99%, whereas the year-over-year growth rate in Q4 2021 was 13.07%. Slowing the growth rate of broad money is the only way to cure the inflation disease, and as a consequence of money growth slowing, a recession will follow. It is crucial that the Fed stays the course and does not endanger the healing process by accommodating more excessive broad money growth; otherwise, the inflation problem will worsen and last longer.