Apr 28, 2020
Thinking Citizen Blog — The Quantity Equation — The Math of Monetary Policy, the Coronavirus, and the Hydra of Inflation
Thinking Citizen Blog — Tuesday is Economics, Finance, and Business Day
Today’s topic: M (stock of money) X V (velocity) = P (price) X Q (Quantity) — The Math of Monetary Policy, the Coronavirus, and the Hydra of Inflation
Alarm bells are clanging. Inflation! Inflation is coming! Inflation is coming! The Fed is printing money like crazy! The more money, the more inflation. Right? Or not? Are there really two factors to consider? The stock of money (M) and the velocity of money (V)? Velocity is the speed at which the money circulates. If the money is not used, no inflation. If you put all that extra money in the mattress, no surge in demand follows. Similarly, if those banks flush with funds from the Fed don’t lend it out, well where is the inflationary pressure? Experts — please chime in. Correct, elaborate, elucidate.
“GET READY FOR THE RETURN OF INFLATION” Tim Congdon, WSJ, 4/23/20
1. “Excluding the years immediately after the Revolutionary War, the past few weeks have seen by far the highest rate of monetary expansion in U.S. history.”
2. “Policymakers have repeatedly called the battle against the novel coronavirus a war. As in wartime, federal expenditures are rising sharply while tax revenues are being hit by the lockdown. Both World War I and World War II — and, indeed, the Vietnam War — were followed by nasty bouts of inflation.”
3. “If that happens again, policymakers today being cheered for their swift, decisive action will instead have to answer for their grave lack of foresight.”
Opinion | Get Ready for the Return of Inflation
THE STOCK OF MONEY IS UP, BUT THE VELOCITY OF MONEY HAS COLLAPSED
1. Between 1960 and the late 1990s, the velocity or money (M2) ranged between 1.65 and 1.9.
2. In the late 1990s, in the frenzy of the Dot.com boom, the velocity rose to 2.2X.
3. Just above 2.0 before the crash of 2008 to 2009, velocity has collapsed to about 1.4X and could well hit levels lower than the 1.2X of the Great Depression.
WHY WAS THE VELOCITY OF MONEY DECLINING EVEN BEFORE THE CORONAVIRUS?
1. Following the financial crisis of 2008 to 2009, the zero interest rate policy of the Fed reduced the incentive for savers to invest and banks to lend.
2. The destruction of wealth caused by the 2008 to 2009 crash led to financial retrenchment.
3. Demographics: the aging of the baby boomers.
NB: For more details: see link below.
8 Reasons Why Everyone Is Hoarding Cash Now
BACKGROUND:
It’s Time for the Fed to Take On the Coronavirus Threat | National Review
The Coronavirus Economy Will Bring Inflation | National Review
https://www.frbsf.org/economic-research/files/S04_P1_JohnVDuca.pdf
Thanks to Larry Franko for bringing this topic to my attention.
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