Whence inflation?

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willthrill81
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Whence inflation?

Post by willthrill81 »

The Federal Reserve's rapid and intense response to the economic situation caused by COVID-19 has alarmed many investors, making them very concerned about inflation. Many are convinced that an increased money supply will inevitably lead to higher inflation. This post is a humble questioning of that logic.

The first graph below is the M3 money supply over the last 10 years. It has more than doubled over this period of time, going from 8.6 trillion to 18.3 trillion.

Image
https://fred.stlouisfed.org/series/MABMM301USM189S

The above graph would strongly suggest to many that inflation must have been very high over the last 10 years. But, on the contrary, inflation has been very low, as the graph below illustrates.

Image

Some have suggested that this is because CPI is grossly understating actual inflation. But there is another explanation, one less controversial and conspiratorial.
The classical theory of inflation, as espoused by the philosopher David Hume and other early thinkers, only considered money growth, which is the increase in the money stock supplied by the government, to be the main cause of inflation, but money growth is a necessary, but not sufficient, condition for inflation. The velocity of money must also be considered, since there can be no inflation unless the money is spent. For instance, if the money supply has expanded, but the people take it home and stuff it in their mattresses, then it will have no effect on inflation.
emphasis added
https://thismatter.com/money/banking/mo ... real%20GDP.

Then what has happened to the velocity of money over the last decade? It has decreased almost in lockstep with the increase in the money supply, as the graph below depicts.

Image
https://fred.stlouisfed.org/series/M2V

The reader will see that 2020 has seen both a rapid increase in the money supply and a rapid decrease in the velocity of money. While, all else being equal, a larger money supply would lead to higher inflation, the additional money in the economy is apparently not changing hands much.

We may see the velocity of money stop falling and even increase in the future, leading to inflation, but the trend we've seen for the last decade and especially this year does not appear to indicate that to be a likely possibility. Perhaps this is why the market is only forecasting inflation over the next 10 years to be 1.73%.
“Good and ill have not changed since yesteryear; nor are they one thing among Elves and Dwarves and another among Men.” J.R.R. Tolkien, The Lord of the Rings
justsomeguy2018
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Re: Whence inflation?

Post by justsomeguy2018 »

willthrill81 wrote: Thu Oct 08, 2020 10:22 am The Federal Reserve's rapid and intense response to the economic situation caused by COVID-19 has alarmed many investors, making them very concerned about inflation. Many are convinced that an increased money supply will inevitably lead to higher inflation. This post is a humble questioning of that logic.

The first graph below is the M3 money supply over the last 10 years. It has more than doubled over this period of time, going from 8.6 trillion to 18.3 trillion.

Image
https://fred.stlouisfed.org/series/MABMM301USM189S

The above graph would strongly suggest to many that inflation must have been very high over the last 10 years. But, on the contrary, inflation has been very low, as the graph below illustrates.

Image

Some have suggested that this is because CPI is grossly understating actual inflation. But there is another explanation, one less controversial and conspiratorial.
The classical theory of inflation, as espoused by the philosopher David Hume and other early thinkers, only considered money growth, which is the increase in the money stock supplied by the government, to be the main cause of inflation, but money growth is a necessary, but not sufficient, condition for inflation. The velocity of money must also be considered, since there can be no inflation unless the money is spent. For instance, if the money supply has expanded, but the people take it home and stuff it in their mattresses, then it will have no effect on inflation.
emphasis added
https://thismatter.com/money/banking/mo ... real%20GDP.

Then what has happened to the velocity of money over the last decade? It has decreased almost in lockstep with the increase in the money supply, as the graph below depicts.

Image
https://fred.stlouisfed.org/series/M2V

The reader will see that 2020 has seen both a rapid increase in the money supply and a rapid decrease in the velocity of money. While, all else being equal, a larger money supply would lead to higher inflation, the additional money in the economy is apparently not changing hands much.

We may see the velocity of money stop falling and even increase in the future, leading to inflation, but the trend we've seen for the last decade and especially this year does not appear to indicate that to be a likely possibility. Perhaps this is why the market is only forecasting inflation over the next 10 years to be 1.73%.
Nice post, a point I might make is that inflation possibly found its way into assets that aren't tracked by CPI (to my knowledge), so instead of consumer inflation we have asset inflation (housing, stocks, etc.). Just thinking aloud....
000
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Re: Whence inflation?

Post by 000 »

The money was spent on (among other things) stocks, precious metals, and bitcoin, i.e. asset inflation YTD:
US Stocks +6.53%
Gold +24.08%
Silver +32.68%
Bitcoin +47.13%

Some locales are reporting soaring housing prices.

Now, as far as CPI inflation goes, with so many things closed, one might say their costs have become infinite, not zero as they are being measured. What's the cost of going to the movie theater? Infinite. Same for anything else that's effectively closed. Also locally grocery stores have been cutting back on their coupon programs; does that show up in CPI, or just list prices?

As far as a longer time frame, like the last decade or two, I think there has been plenty of inflation in housing, healthcare, and higher education.
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Re: Whence inflation?

Post by Dude2 »

Kind of confused, forgive me. If the Fed produced all this new money in an effort to staunch a liquidity crisis, and, in fact, the liquidity crisis was staunched, didn't the newly created money flow somewhere? If the Fed bought assets with the new money, why isn't that figured into the velocity? Is it that the Fed bought the assets and sat on them, so the velocity had a tiny blip but then flat-lined?
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Re: Whence inflation?

Post by jeffyscott »

Dude2 wrote: Thu Oct 08, 2020 10:49 am Kind of confused, forgive me. If the Fed produced all this new money in an effort to staunch a liquidity crisis, and, in fact, the liquidity crisis was staunched, didn't the newly created money flow somewhere? If the Fed bought assets with the new money, why isn't that figured into the velocity? Is it that the Fed bought the assets and sat on them, so the velocity had a tiny blip but then flat-lined?
Not that I knew this before searching, but Money Velocity is "calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock". https://fred.stlouisfed.org/series/M2V

Buying existing assets does not add to GDP.
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nzahir
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Re: Whence inflation?

Post by nzahir »

So a few things:

1) You need velocity of money for there to be inflation
2) CPI is BS
3) Inflation is different depending where you live and by a big difference. Big time inflation in big cities where money is moving and salaries are usually higher. Los Angeles, NY, SF, etc

In LA, the inflation is much higher than 1.8%
not4me
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Re: Whence inflation?

Post by not4me »

jeffyscott wrote: Thu Oct 08, 2020 11:15 am
Not that I knew this before searching, but Money Velocity is "calculated as the ratio of quarterly nominal GDP to the quarterly average of M2 money stock". https://fred.stlouisfed.org/series/M2V
Topic raises many questions with me. note use of M2 (whereas 1st graph in OP is for M3) in calculation. As I understand it, fed quit using m3 in 2006 because it hadn't been used by them in a while. Not sure changing to M2 (or mzm) would change it much though. Since, as you point out, GDP is divided by m2 to get velocity, wouldn't velocity have a math relationship such that if gdp stayed the same, ratio would go down? Might it $s be showing up on fed balance sheet & not in gdp? Maybe it can be explained as fed gives with one hand & takes with the other? If so, what happens when music stops?

anyway, this discussion has been around for a while. Note this from 2014: https://fredblog.stlouisfed.org/2014/08 ... n=fredblog

I look forward to good explantion!
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Re: Whence inflation?

Post by Dude2 »

Honestly the concept that more money created inflation never sat well with me although I was willing to suspend my disbelief. I mean, take a game of Monopoly. If the bank holds an infinite supply of money, who cares? You still get $200 when you pass Go. :)
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Re: Whence inflation?

Post by firebirdparts »

It only has to keep moving if banks lend it. If the Fed, for instance, buys bonds with it, then whoever has the money has to either buy something (or give it away) or not. If they put it in any kind of interest bearing account, then presumably the account administrator has to loan it to somebody and they in turn are exactly in the same situation as the first recipient. This applies to houses and land and stocks and chewing gum, whatever you spend it on. It has to be received by somebody.

It's reasonable to think you can 'create' asset inflation this way, but in practice it's been a bit slow. One issue might be "bank reserves". I don't know how big really they are. If there is a thirst for dollar reserves, then that would swallow it up and it wouldn't be lent. I don't know where else it can really go.

I wish I knew more about it.
Last edited by firebirdparts on Thu Oct 08, 2020 12:47 pm, edited 1 time in total.
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Re: Whence inflation?

Post by alex_686 »

willthrill81 wrote: Thu Oct 08, 2020 10:22 am The first graph below is the M3 money supply over the last 10 years. It has more than doubled over this period of time, going from 8.6 trillion to 18.3 trillion.
There are 2 adjacent solutions.

The first is that M3 is a pretty poor measure of money supply. M3 only measures what is under the Fed preview. What is money? If it quakes like a duck and waddles like a duck it is a duck. So that can be used as money. So stuff that perceived as liquid and safe principle. Things like checking accounts. 1 year treasury bills, money market mutual funds with check writing privileges, short term corporate debt witch is held in that money market mutual funds, and the unused portion of HELOC on your house. If you are scratching your head at the last one then you may not understand the social purpose of banks. It is to take long term illiquid assets (such as a 30 year mortgage) and convert them to short term liquid principal protected bonds. a.k.a. credits. a.k.a. money. One could have a separate topic on near money, but the fact is that it exists and has grown bigger. The problem is that over the past 30 years more and more money creation is slipping away from direct control of the Fed to the shadow banking system. There were major liquidity crunches in 2008 and 2020 that your data is not capturing.

The other is a "Balance Sheet Recession." You touched on it but I am giving it a formal name. The current classic example is Japan. They gorged themselves on debt. When cheap money flowed into the system it went to paying off the old debt instead of going into new productive endeavors or consumer spending. While not as bad, we have spent a good chunk of the past 10 years digging out of the bad debt from 2008.
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Re: Whence inflation?

Post by nedsaid »

Dude2 wrote: Thu Oct 08, 2020 10:49 am Kind of confused, forgive me. If the Fed produced all this new money in an effort to staunch a liquidity crisis, and, in fact, the liquidity crisis was staunched, didn't the newly created money flow somewhere? If the Fed bought assets with the new money, why isn't that figured into the velocity? Is it that the Fed bought the assets and sat on them, so the velocity had a tiny blip but then flat-lined?
As if by magic, the creation of new monies to combat the 2008-2009 financial crisis and later to combat the Covid-19 pandemic have resulted in higher savings rates. If you believe the Sectoral Balances Theory: foreign sector + government sector + private sector = Zero; you would expect that higher government deficits would create higher private sector surpluses. According to the Wikipedia article, we had a government deficit of -3.8% GDP, a foreign sector surplus of 2.4% (which to us is a trade deficit), and a private sector surplus of 1.4% of GDP in 2018. The CARES Act was signed into law on March 27, 2020 and soon after stimulus checks were going out. Kind of weird that the personal savings rate peaked at 33.6% in April 2020. You can also see how the personal savings rate went up from 3.6% in 2007 to 6.4% in 2008 and down a bit to 5.9% in 2009. It isn't a perfect relationship but you can see what appears to be cause and effect.

https://www.statista.com/statistics/246 ... ed-states/

https://en.wikipedia.org/wiki/Sectoral_ ... in%20taxes.

https://tradingeconomics.com/united-sta ... al-savings

As far as velocity of money, one quick example is how much more difficult it is now to secure a mortgage than it was back in 2007. On the chart of Total Reserves of Depository Institutions, you saw a dramatic jump after the 2008-2009 financial crisis and another jump after the Covid-19 pandemic.

https://fred.stlouisfed.org/series/TOTRESNS

So what happened to all those new monies created? Much of the new monies are sitting in people's savings account or sitting as bank reserves of depository institutions.

August 2008 45.8 Billion
August 2014 2.842 Trillion
October 2019 1.547 Trillion
May 2020 3.217 Trillion
July 2020 2.718 Trillion

So this post isn't a perfect explanation for what happened but it gives you some insight.
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Re: Whence inflation?

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000 wrote: Thu Oct 08, 2020 10:41 am As far as a longer time frame, like the last decade or two, I think there has been plenty of inflation in housing, healthcare, and higher education.
This is a common perception, but I'm not sure that the data provide that much support for it over the last decade, at least not for all of those categories.

The prices of newly built homes per sq. ft. has not changed significantly in the last 50 years, much less the last ten. Houses themselves have grown to be much larger over that period of time, but that simply means that people are consuming more housing than before. Certainly a relative handful of areas have seen significant housing inflation, but these have, TMK, mainly been already very expensive places becoming even more so. Also, with housing, it's important to keep in mind that housing prices had recently plummeted ten years ago, so it's only natural for housing prices to have at least somewhat outpaced inflation since then.

Regarding higher ed, the HEPI shows that costs did not materially outpace CPI from 2009-2018 (24.5% cumulative inflation vs. 19.5%).

Healthcare has definitely seen prices go up over the last decade, rising from $8,394 per person in 2010 to $11,172 in 2018, a 33.1% increase relative to CPI's 16.4% over the same period.
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Re: Whence inflation?

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nedsaid wrote: Thu Oct 08, 2020 3:32 pm So what happened to all those new monies created? Much of the new monies are sitting in people's savings account or sitting as bank reserves of depository institutions.
Correct. A big chunk of the newly created money is just sitting on banks' balance sheets. Much of it has also found its way into the portfolios of a very small group of people (not making a political statement at all, just stating a fact). Major corporations' balance sheets have also increased significantly over the last decade. At the end of Q1 in 2010, Apple had $23 billion in cash. At the end of Q2 this year, they had $93 billion.
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Re: Whence inflation?

Post by nedsaid »

willthrill81 wrote: Thu Oct 08, 2020 3:39 pm
nedsaid wrote: Thu Oct 08, 2020 3:32 pm So what happened to all those new monies created? Much of the new monies are sitting in people's savings account or sitting as bank reserves of depository institutions.
Correct. A big chunk of the newly created money is just sitting on banks' balance sheets. Much of it has also found its way into the portfolios of a very small group of people (not making a political statement at all, just stating a fact). Major corporations' balance sheets have also increased significantly over the last decade. At the end of Q1 in 2010, Apple had $23 billion in cash. At the end of Q2 this year, they had $93 billion.
There is also a relationship between budget deficits and cash on the balance sheets of corporations. In the aftermath of the 2008-2009 financial crisis, US Corporations were flush with cash. I suspect cash on Corporate Balance sheets spiked after the CARES Act was passed, particularly High Tech firms, as people were cooped up at home. Lots of money flowed to High Tech/Internet firms.
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Re: Whence inflation?

Post by 000 »

willthrill81 wrote: Thu Oct 08, 2020 3:35 pm
000 wrote: Thu Oct 08, 2020 10:41 am As far as a longer time frame, like the last decade or two, I think there has been plenty of inflation in housing, healthcare, and higher education.
This is a common perception, but I'm not sure that the data provide that much support for it over the last decade, at least not for all of those categories.

The prices of newly built homes per sq. ft. has not changed significantly in the last 50 years, much less the last ten. Houses themselves have grown to be much larger over that period of time, but that simply means that people are consuming more housing than before. Certainly a relative handful of areas have seen significant housing inflation, but these have, TMK, mainly been already very expensive places becoming even more so. Also, with housing, it's important to keep in mind that housing prices had recently plummeted ten years ago, so it's only natural for housing prices to have at least somewhat outpaced inflation since then.

Regarding higher ed, the HEPI shows that costs did not materially outpace CPI from 2009-2018 (24.5% cumulative inflation vs. 19.5%).

Healthcare has definitely seen prices go up over the last decade, rising from $8,394 per person in 2010 to $11,172 in 2018, a 33.1% increase relative to CPI's 16.4% over the same period.
I guess it's all a matter of perception, i.e. on the usefulness of averages. The depressed rural property prices are pulling the average property price down, but may not be relevant to those who need (for work) to live in or near a city.

As far as college costs, it is also necessary to look at the cost versus the value received. Does a B.A. have the same financial value in 2020 as 2002?
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Re: Whence inflation?

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000 wrote: Thu Oct 08, 2020 3:54 pm As far as college costs, it is also necessary to look at the cost versus the value received. Does a B.A. have the same financial value in 2020 as 2002?
To be honest, that's a bit of a rabbit hole. The value received, whether financial or otherwise, from any number of things may have shifted substantially over any 10 or 20 year period of time.
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Re: Whence inflation?

Post by alex_686 »

willthrill81 wrote: Thu Oct 08, 2020 3:35 pm
000 wrote: Thu Oct 08, 2020 10:41 am Regarding higher ed, the HEPI shows that costs did not materially outpace CPI from 2009-2018 (24.5% cumulative inflation vs. 19.5%).
HEPI is deceiving. From 2000 to 2015 HEPI significantly outpaced inflation however what college students actually paid kept pace with inflation.

HEPI measures the official posted price of the college. This is much like the sticker price on a car. A place to start. Colleges get a full look at your finances when you apply and calibrate their aid package to extract as much money as possible. After you factor in grants and scholarships the price falls dramatically.
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Re: Whence inflation?

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alex_686 wrote: Thu Oct 08, 2020 4:13 pm
willthrill81 wrote: Thu Oct 08, 2020 3:35 pm Regarding higher ed, the HEPI shows that costs did not materially outpace CPI from 2009-2018 (24.5% cumulative inflation vs. 19.5%).
HEPI is deceiving. From 2000 to 2015 HEPI significantly outpaced inflation however what college students actually paid kept pace with inflation.

HEPI measures the official posted price of the college. This is much like the sticker price on a car. A place to start. Colleges get a full look at your finances when you apply and calibrate their aid package to extract as much money as possible. After you factor in grants and scholarships the price falls dramatically.
Then please show another data source. I've seen others, and they show largely the same result or even lower inflation of higher ed expenses.
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Re: Whence inflation?

Post by Grt2bOutdoors »

It’s not supply, it’s velocity that affects inflation. I look at M2 instead of M3.
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Re: Whence inflation?

Post by willthrill81 »

Grt2bOutdoors wrote: Thu Oct 08, 2020 4:27 pmI look at M2 instead of M3.
The M2 chart is below. It looks almost identical to M3.

Image
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Re: Whence inflation?

Post by mattz0rt »

I read an extremely thorough analysis recently on the impact of liquidity injections on market valuations: https://www.osam.com/Commentary/upside-down-markets. Warning: the article is very (very) long. But very informative, highly recommend.

As a part of his analysis, the author looked at inflationary impact of the stimulus, and his conclusion was that it would probably have a minimal impact. This is based on looking at how much financial wealth was injected into the system relative to existing wealth (3.2% annualized), which does not even match the lowest amount of annual growth in household income observed sinced 1962 (3.5%).

There are also other factors he mentions, such as income inequality (money eventually makes its way to higher income earners, who withhold at higher rates), anchored inflation expectations by consumers, cost-push deflation (notably the declining price index of durable goods in the last 25 years due to things like globalization and tech), higher private-sector debt levels (which increases withholding), and aging demographics.

As a side note, his conclusion from the analysis, even when using conservative numbers, is that the US stock market potentially has 18% more growth in store when pent-up demand is released and people rebalance back to normal stock/bond ratios.
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Re: Whence inflation?

Post by rich126 »

I've brought this (the velocity thing) up before elsewhere and maybe here. People have been looking for inflation and are obsessed with the money supply and a variety of reasons why it will be occurring, I'll believe it when I see it. I think we are a long way from it and whenever it starts, you'll have plenty of time to adjust your investments. Worrying about inflation now is no different than people 10 years ago saying rates had to go up.
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Re: Whence inflation?

Post by Oicuryy »

For a brief history of the connection between money and prices see
On the Origin and Evolution of the Word Inflation
This Economic Commentary considers the origin and uses of the word inflation and argues that its definition was a casualty in the theoretical battle over the connection between money growth and the general price level. What was once a word that described a monetary cause now describes a price outcome.
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Re: Whence inflation?

Post by 000 »

willthrill81 wrote: Thu Oct 08, 2020 4:05 pm
000 wrote: Thu Oct 08, 2020 3:54 pm As far as college costs, it is also necessary to look at the cost versus the value received. Does a B.A. have the same financial value in 2020 as 2002?
To be honest, that's a bit of a rabbit hole. The value received, whether financial or otherwise, from any number of things may have shifted substantially over any 10 or 20 year period of time.
I don't think so... the value of a home, good health care, adequate nutrition, and so on really haven't shifted.

But I bet the likelihood of getting a high paying job from the average bachelor's degree has shifted over the last twenty years.

If it's now necessary to get a graduate degree for the same job, then educational costs went up.
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Re: Whence inflation?

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000 wrote: Thu Oct 08, 2020 4:45 pm
willthrill81 wrote: Thu Oct 08, 2020 4:05 pm
000 wrote: Thu Oct 08, 2020 3:54 pm As far as college costs, it is also necessary to look at the cost versus the value received. Does a B.A. have the same financial value in 2020 as 2002?
To be honest, that's a bit of a rabbit hole. The value received, whether financial or otherwise, from any number of things may have shifted substantially over any 10 or 20 year period of time.
I don't think so... the value of a home, good health care, adequate nutrition, and so on really haven't shifted.
The financial value of owning a home may very well have shifted, due in no small part to lower interest rates, for instance.

I get your point regarding more education potentially being needed in the marketplace, but that's a separate issue from the cost of education. You're saying that people may need X + Y education, which may be true, but that doesn't change the cost of X.
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Re: Whence inflation?

Post by 000 »

willthrill81 wrote: Thu Oct 08, 2020 4:53 pm The financial value of owning a home may very well have shifted, due in no small part to lower interest rates, for instance.

I get your point regarding more education potentially being needed in the marketplace, but that's a separate issue from the cost of education. You're saying that people may need X + Y education, which may be true, but that doesn't change the cost of X.
Not if the purpose of education under measurement is financial achievement, in which case the correct thing to measure is the total cost of education needed to attain some financial level. Of course if someone attends higher education for other reasons (genuine desire to learn, fun, prestige), then just the naked cost of spending Z years can be compared.
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Re: Whence inflation?

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000 wrote: Thu Oct 08, 2020 5:22 pm
willthrill81 wrote: Thu Oct 08, 2020 4:53 pm The financial value of owning a home may very well have shifted, due in no small part to lower interest rates, for instance.

I get your point regarding more education potentially being needed in the marketplace, but that's a separate issue from the cost of education. You're saying that people may need X + Y education, which may be true, but that doesn't change the cost of X.
Not if the purpose of education under measurement is financial achievement, in which case the correct thing to measure is the total cost of education needed to attain some financial level. Of course if someone attends higher education for other reasons (genuine desire to learn, fun, prestige), then just the naked cost of spending Z years can be compared.
"Financial achievement" is overly broad. If a student was previously getting just bachelor's and is now also getting a master's, that person is consuming more education, and it's logical that they should pay more. That's not inflation. It's greater consumption.
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Re: Whence inflation?

Post by Seasonal »

willthrill81 wrote: Thu Oct 08, 2020 10:22 am The Federal Reserve's rapid and intense response to the economic situation caused by COVID-19 has alarmed many investors, making them very concerned about inflation. Many are convinced that an increased money supply will inevitably lead to higher inflation. This post is a humble questioning of that logic.
Many people have what they regard as common sense models of the economy firmly implanted in their thinking. Two of the most prominent are that a larger base money supply will inevitably lead to inflation and that the government budget is just like a household budget. As far as I can tell, nothing is likely to convince the vast majority of those people otherwise.

BTW, the billion prices project is occasionally useful for those who don't trust the CPI.
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Re: Whence inflation?

Post by willthrill81 »

Seasonal wrote: Thu Oct 08, 2020 5:50 pm
willthrill81 wrote: Thu Oct 08, 2020 10:22 am The Federal Reserve's rapid and intense response to the economic situation caused by COVID-19 has alarmed many investors, making them very concerned about inflation. Many are convinced that an increased money supply will inevitably lead to higher inflation. This post is a humble questioning of that logic.
Many people have what they regard as common sense models of the economy firmly implanted in their thinking. Two of the most prominent are that a larger base money supply will inevitably lead to inflation and that the government budget is just like a household budget. As far as I can tell, nothing is likely to convince the vast majority of those people otherwise.

BTW, the billion prices project is occasionally useful for those who don't trust the CPI.
Maybe we can change the views of at least a few of those who frequent this forum and read this thread.
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Re: Whence inflation?

Post by Armoured »

Dude2 wrote: Thu Oct 08, 2020 12:44 pm Honestly the concept that more money created inflation never sat well with me although I was willing to suspend my disbelief. I mean, take a game of Monopoly. If the bank holds an infinite supply of money, who cares? You still get $200 when you pass Go. :)
Then you lose it when you land/hit "luxury tax".
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Re: Whence inflation?

Post by Steve Reading »

willthrill81 wrote: Thu Oct 08, 2020 10:22 am The Federal Reserve's rapid and intense response to the economic situation caused by COVID-19 has alarmed many investors, making them very concerned about inflation. Many are convinced that an increased money supply will inevitably lead to higher inflation. This post is a humble questioning of that logic.

The first graph below is the M3 money supply over the last 10 years. It has more than doubled over this period of time, going from 8.6 trillion to 18.3 trillion.

Image
https://fred.stlouisfed.org/series/MABMM301USM189S

The above graph would strongly suggest to many that inflation must have been very high over the last 10 years. But, on the contrary, inflation has been very low, as the graph below illustrates.

Image

Some have suggested that this is because CPI is grossly understating actual inflation. But there is another explanation, one less controversial and conspiratorial.
The classical theory of inflation, as espoused by the philosopher David Hume and other early thinkers, only considered money growth, which is the increase in the money stock supplied by the government, to be the main cause of inflation, but money growth is a necessary, but not sufficient, condition for inflation. The velocity of money must also be considered, since there can be no inflation unless the money is spent. For instance, if the money supply has expanded, but the people take it home and stuff it in their mattresses, then it will have no effect on inflation.
emphasis added
https://thismatter.com/money/banking/mo ... real%20GDP.

Then what has happened to the velocity of money over the last decade? It has decreased almost in lockstep with the increase in the money supply, as the graph below depicts.

Image
https://fred.stlouisfed.org/series/M2V

The reader will see that 2020 has seen both a rapid increase in the money supply and a rapid decrease in the velocity of money. While, all else being equal, a larger money supply would lead to higher inflation, the additional money in the economy is apparently not changing hands much.

We may see the velocity of money stop falling and even increase in the future, leading to inflation, but the trend we've seen for the last decade and especially this year does not appear to indicate that to be a likely possibility. Perhaps this is why the market is only forecasting inflation over the next 10 years to be 1.73%.
Great thread, thanks for the info Will!
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Re: Whence inflation?

Post by whereskyle »

nzahir wrote: Thu Oct 08, 2020 11:33 am So a few things:

1) You need velocity of money for there to be inflation
2) CPI is BS
3) Inflation is different depending where you live and by a big difference. Big time inflation in big cities where money is moving and salaries are usually higher. Los Angeles, NY, SF, etc

In LA, the inflation is much higher than 1.8%
Miami too
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Re: Whence inflation?

Post by bottlecap »

The government calculates inflation stupidly. Likely because it masks true inflation. Money doesn’t flow only into goods that are in the CPI. It flows into stocks, bonds, real estate and innumerable other things.

Velocity of money can be a symptom, but not a cause. Velocity of money doesn’t affect how I determine how much I’m willing to pay for goods (which, whether you agree or not, is how the CPI measures inflation, at least with respect to a limited number of goods). I doubt it factors into anyone else’s decisions, either.

JT
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Re: Whence inflation?

Post by fwellimort »

I don't know about you all but in major cities, inflation has been quite rampant the past 10 years.
Even goods. Prices of avocado sandwiches are quite something today.

There's enough controversy with CPI that even investopedia has a page on "The Controversy"
https://www.investopedia.com/articles/0 ... on%20rate.

It all depends how you "define" inflation. If you are the government, you can re-define "inflation" whenever the scale goes off.
I think the best method is to look at your credit card bills. If you have been purchasing similar goods year to year, then calculate inflation from your everyday purchases.
Your local inflation matters far more than the government's reported CPI.

Then there's "asset appreciation" like health / education / stocks / bonds / commodities like gold / cryptocurrencies.
Again, as long as the government 're-defines' inflation, who knows.
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Re: Whence inflation?

Post by Alchemist »

Anyone concerned about inflation right now has completely missed the boat on what is happening (looking at you, ECB...). Deflationary economic depression is the danger, NOT inflation. We have too many people re-living the 1970's when they should be more concerned about re-living the 1930's. Demand has fallen off a cliff due to the pandemic. The government must run huge deficits to make up the slack in demand or risk a depression.

Inflation is the goal right now, not the enemy.
nedsaid wrote: Thu Oct 08, 2020 3:47 pm There is also a relationship between budget deficits and cash on the balance sheets of corporations. In the aftermath of the 2008-2009 financial crisis, US Corporations were flush with cash. I suspect cash on Corporate Balance sheets spiked after the CARES Act was passed, particularly High Tech firms, as people were cooped up at home. Lots of money flowed to High Tech/Internet firms.
The public sector's deficit is a private sector surplus. The opposite is also true, when the public sector runs a surplus it requires the private sector to run a deficit. Deficits are not necessarily bad and surpluses are not necessarily good. It depends on what the greater context in the economy looks like to determine how small/big the deficit should be. As in, if experiencing bigger than desired inflation you should reduce the deficit. If inflation is stubbornly low or risking deflation, run a bigger deficit.

Another factor here is a few trillion of the 'new' money was the Fed buying treasuries. Most people, mistakenly, believe that U.S. government bonds are debt. They are not. Treasuries are just interest bearing dollars. The Fed swapping treasuries for dollars affects interest rates but does not really change the amount of 'dollars' in the market.
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Re: Whence inflation?

Post by WS1 »

Housing

Yes, prices rose because homes are larger, but we can’t gloss over that construction prices per sq. Ft should have been innovated downwards like many other products. The lack of productivity gains in construction is something “people study.” Another huge driver is urban land costs. Job growth has been in cities and aggressively maintained single-family zoning (hobbling the market) will send land prices to the moon. See the writings on zoning by people like Kevin Erdmann or any YIMBY radical.

Prices
It would appear we all have our own inflation rates
https://www.aei.org/carpe-diem/chart-o ... 7-to-2017/
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Re: Whence inflation?

Post by z3r0c00l »

fwellimort wrote: Thu Oct 08, 2020 7:27 pm I don't know about you all but in major cities, inflation has been quite rampant the past 10 years.
Even goods. Prices of avocado sandwiches are quite something today.
I live in NYC and have not seen prices increase by all that much in the last 10 years. Housing is getting cheaper if anything and I get avocados 4 for $5. Maybe people are having personal lifestyle creep and confusing that with inflation? This whole hidden inflation conspiracy theory falls flat upon further investigation. Everything is incredibly cheap including gas, electronics, clothing... Heck I can go out now and buy a 65 inch 4K tv for under $500. This was how much a 20 inch color TV cost in 1985. (Without adjusting for inflation.)

As someone just said above, deflation is our likely fate here, and that is what the FED is worried about. A vicious deflationary cycle is very likely with this much unemployment, that's how this could become a depression.
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Re: Whence inflation?

Post by willthrill81 »

z3r0c00l wrote: Thu Oct 08, 2020 8:12 pm
fwellimort wrote: Thu Oct 08, 2020 7:27 pm I don't know about you all but in major cities, inflation has been quite rampant the past 10 years.
Even goods. Prices of avocado sandwiches are quite something today.
I live in NYC and have not seen prices increase by all that much in the last 10 years. Housing is getting cheaper if anything and I get avocados 4 for $5. Maybe people are having personal lifestyle creep and confusing that with inflation? This whole hidden inflation conspiracy theory falls flat upon further investigation. Everything is incredibly cheap including gas, electronics, clothing... Heck I can go out now and buy a 65 inch 4K tv for under $500. As someone just said above, deflation is our likely fate here, and that is what the FED is worried about. A vicious deflationary cycle is very likely with this much unemployment, that's how this could become a depression.
I agree that the notion of a big inflation conspiracy is unfounded by real data.

It's very narrow and a bit funny, but blogger Len Penzo has been tracking the cost of sandwich ingredients in the LA area for 12 years now. It does not indicate that CPI is a gross understatement of inflation, at least when it comes to simple foods. It's actually quite surprising to see how much prices on individual items swing in price from year to year. For instance, mayonnaise dropped in price by 23% while mustard went up by 25%. The turkey and swiss cost double in 2015 what it did in 2009 but now costs less than in 2009.

Image
https://lenpenzo.com/blog/id56145-my-12 ... iches.html
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Re: Whence inflation?

Post by z3r0c00l »

Seeing a gradual increase in my fav. Vietnamese sandwich. Moved here and started eating it weekly just over 10 years ago. Then it was $4.75, a few years later jumped up to $5.00, then $5.25, $5.50, and now it is $6.00. That is about 26% total or a CAGR of 2.36%. My rent has gone up a comparable amount. Both barely kept pace with inflation and $6 feels like less now than it did then because my salary increased at a higher rate by far. Maybe this inflation thing is overrated for those of us most frugal types who can control our cost of living.
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Re: Whence inflation?

Post by JBTX »

Good analysis - other points to consider:

Velocity of money is hard to predict. I remember 30 years ago in my economics class the assumption taught was velocity is fairly constant. The events of the past couple of decades show that may not be the case.

It isn't unreasonable to think that velocity stabilizes or goes back up whenever things get back to normal, but ultimately only time will tell.

In the past I was always annoyed by doomsdayers and goldbugs claiming real inflation is higher, but I am starting to see at least some validity to it. Apart from energy it just seems like we are seeing more inflation than in years past. Part of that is due to standard of living adjustments or basket of goods adjustments with cpi.

We are seeing inflation in assets, which of course is not consumer price inflation. To the extent additional printed money flows to upper incomes it is more likely to flow into non cpi investments like stocks and housing and not as much consumer items.

People like Dahlio are credibly asserting that with all of the monetary stimulus we will likely see a falling dollar. If that continues eventually that has to lead to at least some modest inflation
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Re: Whence inflation?

Post by nedsaid »

Ben Felix has a good video out on YouTube: Understanding the Fed's "Money Printer" (QE, the Stock Market, and Inflation).

He says something someone controversial but it has been established elsewhere, that is bank reserves have no effect upon actual bank lending. What constrains bank lending is the profitability of its loans not the amount of reserves held by the bank. Money is created out of thin air when the bank creates a loan which in turn becomes someone's deposit.

If bank reserves have no effect upon lending, there really is no money multiplier effect and there really is no velocity of money. At least that is what crossed my mind, perhaps others can comment and shed light on this.

Felix recommends Cullen Roche and his blog Pragmatic Capitalism which explains how the modern monetary system works.

https://www.youtube.com/watch?v=K3lP3BhvnSo
Last edited by nedsaid on Thu Oct 08, 2020 9:05 pm, edited 1 time in total.
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Re: Whence inflation?

Post by nedsaid »

Alchemist wrote: Thu Oct 08, 2020 7:39 pm
Another factor here is a few trillion of the 'new' money was the Fed buying treasuries. Most people, mistakenly, believe that U.S. government bonds are debt. They are not. Treasuries are just interest bearing dollars. The Fed swapping treasuries for dollars affects interest rates but does not really change the amount of 'dollars' in the market.
I have made the radical statement that the U.S. Federal Debt really doesn't finance anything. I said that the interest paid on Treasury instruments helps the Fed target interest rates and also is a factor in supporting the value of the dollar. All other things being equal, relatively high interest rates compared to other currencies helps keep a currency strong compared to other currencies with lower interest rates. The Federal Debt is also a risk free way for local and State governments, private businesses, and private individuals to stash their savings. Paper currency is really nothing more than a zero percent interest loan, our currency says "Federal Reserve Note."

Maybe I am just getting crazy as I get older but standard textbook explanations of how all of this works falls short.
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Re: Whence inflation?

Post by Forester »

Inflation has been high in the 2010s. 20% money debasement, despite depressed global growth and the ongoing disinflationary pressure of technology. Government deficit spending could be disinflationary in its own way if it retards genuine economic activity.
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Re: Whence inflation?

Post by willthrill81 »

nedsaid wrote: Thu Oct 08, 2020 8:55 pm Ben Felix has a good video out on YouTube: Understanding the Fed's "Money Printer" (QE, the Stock Market, and Inflation).

He says something someone controversial but it has been established elsewhere, that is bank reserves have no effect upon actual bank lending. What constrains bank lending is the profitability of its loans not the amount of reserves held by the bank. Money is created out of thin air when the bank creates a loan which in turn becomes someone's deposit.

If bank reserves have no effect upon lending, there really is no money multiplier effect and there really is no velocity of money. At least that is what crossed my mind, perhaps others can comment and shed light on this.
Reserves did impact lending for many years because commercial banks were required to hold 10% in reserve. The Fed eliminated that requirement back in March.
As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.
I'm quite surprised that I didn't hear about that until I just discovered it. It seems rather momentous.

Does this mean that a commercial bank can lend an infinite amount of money? I'd have to think no, but what constrains them now?
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Re: Whence inflation?

Post by vitaflo »

I always assumed increasing income inequality meant decreasing inflation, regardless of the total money available. The rich just sit on their money, and the poor don't have enough to increase the demand for anything.
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Re: Whence inflation?

Post by nedsaid »

willthrill81 wrote: Thu Oct 08, 2020 9:21 pm
nedsaid wrote: Thu Oct 08, 2020 8:55 pm Ben Felix has a good video out on YouTube: Understanding the Fed's "Money Printer" (QE, the Stock Market, and Inflation).

He says something someone controversial but it has been established elsewhere, that is bank reserves have no effect upon actual bank lending. What constrains bank lending is the profitability of its loans not the amount of reserves held by the bank. Money is created out of thin air when the bank creates a loan which in turn becomes someone's deposit.

If bank reserves have no effect upon lending, there really is no money multiplier effect and there really is no velocity of money. At least that is what crossed my mind, perhaps others can comment and shed light on this.
Reserves did impact lending for many years because commercial banks were required to hold 10% in reserve. The Fed eliminated that requirement back in March.
As announced on March 15, 2020, the Board reduced reserve requirement ratios to zero percent effective March 26, 2020. This action eliminated reserve requirements for all depository institutions.
I'm quite surprised that I didn't hear about that until I just discovered it. It seems rather momentous.

Does this mean that a commercial bank can lend an infinite amount of money? I'd have to think no, but what constrains them now?
From what I read, from an operational and practical view, bank reserves had no effect upon bank lending even before the requirement was lifted. Not sure exactly why that was, I will have to go back to Pragmatic Capitalism and research this. My suspicion is that the bank could just borrow the reserves from elsewhere. The theory is that the bank could leverage your deposit about 10:1 but in actual practice, this might not have been true. It seems there was a difference between the textbook explanation and how things worked in real life.

I suppose what constrains bank lending is regulation, banks are highly regulated. If a bank tried to make infinite loans, at some point regulators would step in. Loan standards would also constrain bank lending. A third constraint would be the size of your staff, the loan officers, the people who service the loans, and the analysts. A fourth constraint would be the financial soundness of the bank. Banks are required to have a certain amount of capital. Again, I would like an actual banker to comment upon this. What Ben Felix said was that the profitability of the loans was the ultimate constraint. When enough loans become non-performing, lending standards tighten.
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Re: Whence inflation?

Post by 000 »

Alchemist wrote: Thu Oct 08, 2020 7:39 pm Anyone concerned about inflation right now has completely missed the boat on what is happening (looking at you, ECB...). Deflationary economic depression is the danger, NOT inflation. We have too many people re-living the 1970's when they should be more concerned about re-living the 1930's. Demand has fallen off a cliff due to the pandemic. The government must run huge deficits to make up the slack in demand or risk a depression.
Isn't deflation easier for the government to fight than inflation (easier to increase than decrease the money supply)?
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Re: Whence inflation?

Post by bottlecap »

willthrill81 wrote: Thu Oct 08, 2020 8:22 pm
z3r0c00l wrote: Thu Oct 08, 2020 8:12 pm
fwellimort wrote: Thu Oct 08, 2020 7:27 pm I don't know about you all but in major cities, inflation has been quite rampant the past 10 years.
Even goods. Prices of avocado sandwiches are quite something today.
I live in NYC and have not seen prices increase by all that much in the last 10 years. Housing is getting cheaper if anything and I get avocados 4 for $5. Maybe people are having personal lifestyle creep and confusing that with inflation? This whole hidden inflation conspiracy theory falls flat upon further investigation. Everything is incredibly cheap including gas, electronics, clothing... Heck I can go out now and buy a 65 inch 4K tv for under $500. As someone just said above, deflation is our likely fate here, and that is what the FED is worried about. A vicious deflationary cycle is very likely with this much unemployment, that's how this could become a depression.
I agree that the notion of a big inflation conspiracy is unfounded by real data.
I’m not shocked that you agree with someone that agrees with you.

I guess your concept of "real data" is all in how you define inflation. You tend to agree with the definition the politicians prefer, but the fact that you can get a tv for cheap is not a product of deflation or noninflation, but because of increases in productivity not accounted for by government measures of inflation. Productivity advances significantly mask the affects of inflation, regardless of whether we're talking about TVs or sandwiches. It’s just that major advances in productivity in certain industries significantly understate the effect of inflation overall.

JT
Last edited by bottlecap on Thu Oct 08, 2020 11:18 pm, edited 1 time in total.
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Re: Whence inflation?

Post by bedon »

000 wrote: Thu Oct 08, 2020 11:03 pm
Alchemist wrote: Thu Oct 08, 2020 7:39 pm Anyone concerned about inflation right now has completely missed the boat on what is happening (looking at you, ECB...). Deflationary economic depression is the danger, NOT inflation. We have too many people re-living the 1970's when they should be more concerned about re-living the 1930's. Demand has fallen off a cliff due to the pandemic. The government must run huge deficits to make up the slack in demand or risk a depression.
Isn't deflation easier for the government to fight than inflation (easier to increase than decrease the money supply)?
Deflation is pretty tough to fight - Japan has been fighting deflation since the beginning of the 90's. Economists are generally more scared from deflation than they are from inflation (not hyperinflation).
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Re: Whence inflation?

Post by JoMoney »

vitaflo wrote: Thu Oct 08, 2020 9:25 pm I always assumed increasing income inequality meant decreasing inflation, regardless of the total money available. The rich just sit on their money, and the poor don't have enough to increase the demand for anything.
For what it's worth, there is a lot more turnover among the top 1% (or whatever top percentile) then some people realize, it's not the same "rich" people out there "sitting on their money". New wealth is created, and many new rich displace the ones "sitting on their money". It's not a zero-sum situation where the amount of wealth or money is static. While "inequality" increasing is a problem, the "poor" aren't getting poorer.


https://www.aei.org/carpe-diem/q-how-mu ... americans/

https://www.federalreserve.gov/econres/ ... units:mean
Last edited by JoMoney on Thu Oct 08, 2020 11:31 pm, edited 2 times in total.
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