Inflation: Supply, Demand & Velocity

Inflation, which has been a major concern to every American, has taken center stage of the US economy. To grasp the complexities of inflation, it's imperative to comprehend its essence. Originally defined as an increase in the money supply, the concept evolved about a century ago to represent the persistent uptrend in the general price level of goods and services. Over the past two decades, the US economy has witnessed a gradual core inflation averaging around 3.5% per year till 2020. This phenomenon is primarily attributed to the expansion of the money supply, particularly the M2 money supply, which has surged by a significant 320% since 2000. However, it was the year 2020 that marked a pivotal turn, thrusting inflation into a spotlight of heightened concern. This article takes a dive into the interplay of money supply, velocity, and their impact on inflation today, while highlighting the pivotal events that have shaped the trajectory of the US economy.

The Money Supply Surge

The last two decades have seen a substantial growth in the US money supply. This growth escalated notably in 2020, witnessing a 40% surge in M2 money supply in just two years. This monetary expansion, controlled by the Federal Reserve, conflicts with the central bank's mandate from Congress, which aims to maintain maximum employment and stable prices with a targeted 2% annual inflation. The aftermath of the 2008 recession spurred new central bank tools like quantitative easing, where the central bank purchases government bonds to inject fresh digitally-printed money into the economy, coupled with a drop in interest rates to 0% to stimulate consumer spending, these actions sought to invigorate the economy. While the initial years witnessed inflation that no one really noticed between 2000 and 2020, the recent expansionary policies have culminated in recent years’ causing concern of the recent trend of inflation averaging 5.5% (20% in total over the past three years).

The Inflation Catalyst: Surge and Contraction

The pivotal shift in inflation dynamics began to unfold in 2020. The Federal Reserve's purchase of $4 Trillion worth of US bonds triggered a substantial increase in total money supply from $16 trillion in 2019 to $22 trillion 2022—a wild 30% surge. This acceleration underscored the sensitivity of price levels to rapid monetary expansion. In

M2 Money Supply Federal Reserve Total Bond Purchases 2008-2023

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By Golden Coast Consultants

Issue #10 August 24, 2023

Data

Core Inflation avg 3.5% 2000-2023

a recent shift, the money supply has contracted by approximately four percent over the past year, mainly due to policy changes by the Federal Reserve, including the fastest interest rates rise from 0% to 5.5% in US history.

Money Velocity: Deciphering the Circulation Enigma

Money velocity, a cornerstone of runaway inflation dynamics, gauges the pace at which money circulates within an economy. While the past two decades saw subdued money velocity, several factors like the 2001 and 2008 US events hindered spending and kept demand for goods low. However, the scenario today has transformed with an unprecedented money velocity of 10.5% year- over-year surge—an indication that previous stored money is now being exchanged for goods at an alarming fast rate. This acceleration has created a demand-supply mismatch, potentially contributing to price surges as demand outpaces supply, this causes supply shortages.

Navigating the Challenge of Inflation

Amidst the rising inflation challenge, the Federal Reserve are grapple with complex decisions. The expansion of the money supply has undoubtedly fueled inflationary tendencies, but the surge in money velocity has added an intricate layer to the equation. Striking a balance between supply and demand dynamics within the monetary realm is now paramount.

Regaining Control: Achieving Monetary Equilibrium

Addressing the risks posed by runaway inflation necessitates a balanced approach. While reducing demand for money may appear counterintuitive, it is a necessary step. This phenomenon is evident in the real estate sector, where mortgage demand has hit record lows. However, the overarching concern lies in the substantial US government deficits—hovering around $2 trillion annually— indicating an injection of money into the economy exceeding tax revenues, barring instances like the 2020 lockdowns.

Conclusion: Charting the Path Ahead

Between money supply expansion, heightened money velocity, inflation presents a multifaceted challenge for Americans, Government and the Federal Reserve. The consequences of unchecked inflation have far-reaching implications, destroying purchasing power, economic decay, and financial instability. As the nation navigates these challenges, history stands as a testament to the urgency of vigilant actions and prudent intervention. To ensure a stable path forward, a strategic equilibrium must be established, safeguarding the economy against the potential perils of unbridled inflation.Thanks for reading The Coastal Journal ! Subscribe for free to receive new posts and support my work.