The United States Congress and the Federal Reserve have been conspiring to create incredible quantities of dollars out of thin air. The “M1” money supply estimate increased 70% in the past year. The “M2” and “M3” money supply estimates increased around 25%.* So it’s not surprising that people are talking about inflation** and we are seeing prices rise. But I read economists saying inflation won’t exceed 2.5% and the Fed has things under control.
If you pay attention to consumer prices then you know that they have been creeping—and sometimes jumping—up. It seems like more than 2.5% to me, but I haven’t tried to do a study. On the other hand, prices haven’t increased 70%, or even 25%, except maybe gasoline. How can all that money be sloshing around and not increase prices?
I’m sure you know that market prices are set by supply and demand. On the one hand there is the supply of and demand for the product or service to be purchased. On the other hand there is the supply of and demand for the dollars to be given in exchange. But there’s more. Supply and demand are, at least partially, determined by competition. Your demand for beef is affected by the availability of chicken. Your demand for dollars is affected by that boat you are saving up to buy. So purchasing one good, thus removing it from the market, can increase demand for alternative goods. It is by competing to purchase scarce goods and services that increased money supply increases prices.
This means all that money won’t increase prices until it is spent. It will take the years to figure out how to spend that much money, with a large fraction of it going to pay people to figure out how to spend it. It also means that regardless of what the money is spent on, it will lead to increased prices for lots of unrelated items. Goods and services don’t instantly appear just because money is available. It takes real people doing real work over a period of time to produce stuff. Factories take years to design and build. Hiring and training people takes time.
At 2.5% inflation it would take 10 years to absorb a 25% increase in money supply and 23 years to absorb a 70% increase, if all other things remain constant. (Other things never actually remain constant.) It seems to me that if they try to force all that money into the economy (by paying people and buying stuff) faster than that then inflation will have to exceed 2.5%.
Disclaimer: I’m not an economist, so take my economic opinions with however many grains of salt you wish.
* Estimated from charts at shadowstats.com.
** Here I use the word “inflation” to mean an average increase in consumer prices. Some economists disapprove of this usage.
Posted 2021/04/05