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Writer's picturePavel Kohout

What "Temporary Inflation" Really Means

Growth in the U.S. liquid money supply (the M2MNS aggregate) peaked at more than 30 percent year-on-year in February 2021. By March 2020, however, monetary inflation had already surpassed 10 percent and continued to rise. Now, after more than 18 months of double-digit growth in the amount of money in the economy, many economists are surprised by the rise in price inflation (CPI), and are debating whether it is temporary or permanent.


It is a sad testament to the profession's superficial understanding of the concept of inflation. Consider the following chart. During the pandemic, we saw massive monetary inflation that coincided with a slight decline in the CPI. The explanation? Central bankers were panic-stricken about a deflationary spiral, so they pumped money at the top. Apparently they believed -- God only knows why -- that the velocity of money circulating in the economy would soon fall to zero. They were completely wrong.


Money supply (blue), consumer price inflation (red), US


The consumer price index temporarily fell by about one percent at the beginning of the pandemic. Meanwhile, monetary inflation has been in double digits. Economists and central bankers are now "shocked" to find that the consumer price index is rising, lo and behold, to 5.4 percent year-on-year (September 2021). Are they really so naive as to expect that the most massive monetary expansion since the first half of the 1980s will go without consequences? Have they completely forgotten the basics of the Quantity Theory of Money?


Speaking of the question whether the price inflation is temporary or permanent -- it is of course temporary. How we define "temporary" is another question.


One more thing. Few people like to hear "I told you so", but gosh, I really did tell you so, namely on 31 August 2020 in Lidové noviny:


Nobody is worried about inflation. The money supply in the Czech economy grew by 13 per cent year-on-year (in June 2020), in the eurozone by 12.6 per cent, in the US by 30 per cent, in Canada by 19.5 per cent. The growth of the money supply is already reflected in property and, to a large extent, stock prices. The rise in stock prices probably bothers few people, but what about property? Central bankers remain calm because flats and houses are excluded from inflation calculations. However, it remains to be seen what social consequences expensive housing may have in the long term.


Sometimes I am not happy when my predictions come true. By the way, I don't really think badly of central bankers: I wouldn't say they are stupid. Their IQ is undoubtedly in the average range.

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