When Paul Volcker fought inflation, the way he did it was letting interest rates go higher than the inflation rate. The graph below has 10 year interest rate (blue), the inflation rate (red), and then the difference between these (green). When the green line was far below zero Volcker was fighting inflation hard.
As Milton Friedman taught, inflation is always and everywhere a monetary phenomenon, but there are long and variable delays between Fed policy inputs and the inflation result. It can take years for inflation to show up, or go away, after a Fed policy change.
For the last few years the green line has been near zero and above, similar to the 1970s. Having interest rates below the inflation rate is once again encouraging inflation. Inflation is starting to show in measures like the CPI.
Intuitively this makes sense. If it is possible to borrow money at rates below the inflation rate then lots of companies and people are going to borrow money, which will cause the banks/fed to increase the money supply, which will cause more inflation.
Low interest rates does not necessary mean high inflation, because the economy could move into a recession and financial assets simply increase in value.
ReplyDeleteInflation is a function of higher wages (e.g. nationalization policy, moving away from globalization), supply chain disruptions and devaluing reserve currency. Therefore, it is possible to have a low interest rate policy, with low inflation as long as globalization and wages do not rise exponentially. Plus, automation and productivity increases are deflationary... as shown by the Great Financial Crisis... instead financial assets increased in value as more people
and companies borrowed to invest and not consume/increase GDP.
What I meant is that as long as there's continual globalization (ie lower costs to US consumers) and minimum wages do not increase exponentially, then there should not be much inflation even if the US increases the MS and devalues its currency relatively. Since it seems that gold does not increase in value simply due to devaluing of the USD or else it should have reached record highs during covid19... instead it seems to react to inflation and it is possible to increase MS without increasing inflation.
DeleteI don't believe that there's a direct relation between the fed increasing the money supply and there being more inflation...
ReplyDelete