The Factors of Price Inflation and Hyperinflation

Chris Casey has written an article that was published as a daily article on  The theme of his piece is regarding the vast increase in the money supply, especially the monetary base, over the last 5 years and how it will likely eventually translate into higher price inflation.  He touches on other issues affecting price inflation such as excess reserves and the demand for money.

Casey concludes that much higher price inflation is likely in the not-too-distant future.  Overall, I think his article is a good summary of what is happening currently.  Probably 99 out of 100 Americans would not know or understand much of what he is discussing.

I do have a couple of quips with his otherwise excellent article.  One is a minor factual issue and the other is more substantial.

First, in the section of his article where he is writing about the Fed purchasing assets, he said that the Federal Reserve “committed to monthly asset purchases of $85 billion” on September 13, 2012.  But this is a little misleading in that the Fed was only announcing the creation of $40 billion per month (in mortgage-backed securities) at that time.  The rest of the purchases was part of its “Operation Twist” program in which it bought longer-term securities while selling shorter-term securities.  So while the Fed was buying $85 billion per month, it was only adding $40 billion in net new money at that time, as $45 billion in shorter-term debt was being sold.  It wasn’t until three months later that the Fed announced that it would actually be expanding the monetary base by $85 billion per month.

Second, and far more importantly, Casey writes near the end of his piece (just before the conclusion) the following:

“It is important to note that regardless of any future curtailment of monetary expansion, the inflationary forces are already within the system.  It does not matter if the Federal Reserve ends its ‘highly accommodative stance on monetary policy.’  Its past actions will have a pronounced future reaction.”

While I agree that the Fed’s past actions will have consequences (and are already having severe consequences in helping to misallocate resources), I disagree that it does not matter if the Fed changes its monetary policy.

I think the late 1970s and early 1980s show that it matters a great deal.  That was a time when there was already high price inflation.  When Paul Volcker stepped in and stopped creating new money and allowed interest rates to rise, it eventually put a halt to the severe price inflation.  People regained their trust in the dollar.  The U.S. went through a really tough recession (or two), but the actions of Volcker and the Fed essentially saved the dollar at that time.

If the Fed were to announce tomorrow that it would stop all of its quantitative easing immediately, at least for a period of several years, then I am doubtful that we would see any serious price inflation, assuming that the Fed was telling the truth and that people believed what was being said.  We would hit a severe recession or depression, but it would really likely offset much or all of the previous monetary inflation that took place.  It doesn’t automatically repair all of the previous damage done, but it prevents more damage from being done in the future.  It would cause a major liquidation and reallocation of resources.  But there is little question that confidence in the dollar would rise and the demand for money would rise significantly.

It is true that price inflation typically follows monetary inflation, but it doesn’t always have to be this way either.  The demand for money (velocity) is just as important.  It is just that the demand for money typically will go down when there is severe monetary inflation.  I suppose that the current time we live in is somewhat unique in the sense that there is high monetary inflation, yet the demand for money has not weakened yet.

It is also technically possible to have high price inflation, or even hyperinflation, without having an increasing money supply.  If everyone woke up tomorrow as a student of Austrian school economics and suddenly believed that the dollar should no longer serve as money, then it is possible for the demand for the dollar to go way down (high velocity), sending the value of the dollar way down.  Again, this is not likely, but it is not impossible.

In conclusion, it is important to understand all of the aspects that affect overall price inflation.  If you don’t factor everything in, it is easy to get burned with bad predictions.  While higher price inflation in the near future looks like a good bet, it is not inevitable.