WHAT CAUSES INFLATION?

Continuous from old to new

#185

I would like to thank Dick for being a loyal blog reader and passing on to me the article Rapid Money Supply Growth Does Not Cause Inflation at https://evonomics.com/moneysupply/

Inflation is a pervasive rise in the average price level. People expect low inflation rates, but high rates can destroy economies, especially when erratic and unanticipated. Indeed, a rapid money supply growth may not always cause inflation because an increase in the money supply is only one of four factors that can cause inflation. Economists use the formula P = MV/Q, where P is the price level, M is the money supply, and V is velocity, which is how quickly a dollar changes hands. For example, during boom times, a dollar will circulate among people rapidly, but in depression, velocity diminishes. Q is the number of goods and services. Everything else being equal, if the quantity of what money can buy increases, prices will decline, and prices will increase when the amount of goods and services decreases. A fourth factor is the value of a currency on the world market. If the dollar’s value rises relative to other world currencies, the price of foreign products declines for Americans and vice versa.

The war in Ukraine and the sanctions imposed on Russia have caused the supply of Russian products, gas, oil, fertilizer, etcetera to decline on the world market. As Russian exports fall while demand holds steady, this scarcity is already causing the value of Russian products to increase. The lack of Russian products on the world market increases the value of the Russian ruble, causing foreign prices to decline for Russians. The opposite is happening in the western world. The sanctions drive gas and oil supply to decrease and the cost to increase, at least for Europeans. This coming winter, most Europeans will not be able to heat their homes, operate their factories, or drive their cars. Because of the sanctions imposed on Russian products, America and Europe will experience high food prices and critical food shortages. Russians will have a surplus of energy, low prices, and an abundance of food. America’s sanctions against Russia will destroy the western world’s economies, including the US while benefiting Russia over the long run, especially as Russia finds new customers in the east.

We are about to experience a repeat of the 1970s when America had stagflation. The economy was stagnating while the price level increased. Inflation was caused by an increase in the money supply more than the economy produced goods and services. If we were on some gold standard, authorities could not increase the money supply unless gold reserves increased. But because nothing backs up a fiat currency, monetary authorities can raise the money supply at will. In the 1970s, when the countries of OPEC increased the oil price, the general price level increased because oil is a necessity with few substitutes. The same thing is happening today because of the sanctions against Russian gas and oil. In the 1970s, if the monetary authorities held tight to the money supply, the price level would have declined in short order. But to combat the growing unemployment problem, the Federal Reserve significantly increased the money supply. The prime interest rate was 21 percent in the early 1970s, while inflation averaged ten percent per annum. According to JP Morgan CEO Jamie Dimonwe should brace for an economic hurricane soon with storm clouds forming on the economic horizon

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Published by Kenneth E. Long

Author, college professor of economics, swimming and tennis enthusiast

4 thoughts on “WHAT CAUSES INFLATION?

  1. My understanding is that the definition of “inflation” has changed, from an increase in the money supply to a general increase in prices. Could you address this? Thank you.

    Liked by 1 person

    1. Hello Daniel,
      Inflation is a general increase in the price level. An increase in the money supply can cause inflation, everything else being equal. For example, if we experience a shortage of oil and because oil is a necessity with few substitutes, the price of oil and oil derivatives will increase. But if consumers do not have more money, they will spend less on goods that are not related to oil. Thus, the price of oil-related items will increase, but other items’ prices may decrease. Therefore, the average price level will stay the same. So to have an increase in the general price level, the money supply has to increase. Because we are on a fiat money system, monetary authorities can raise the money supply willy-nilly. To get a clear picture of inflation, you have to consider the world economy, not just the American economy.
      I hope this helps. How did you find out about my blog?
      Take good care,
      Ken

      Like

  2. When I was a young naive man, I voted for Jimmy Carter to be President. My first time voting. That turned out to be a huge mistake. With some education followed, I could not wait to vote him out and Ronald Regan in.
    With Joe Biden we have JimmyCarter2.0 and his entire administration is devoid of any measure of intelligent fiscal policy. His inflation and policies are driving us over a recession cliff unless we can somehow hit the brakes. All I can picture is “Thelma and Louise”.

    Liked by 1 person

    1. Hello Jeff,
      I retrieve the Roanoke Times every morning from my neighbors’ mailbox and put it on their front porch. So I get a chance to read some of it. Basically, the paper is propaganda for the establishment. So to my surprise, it had an article on the front page about how the west’s sanctions against Russia are benefitting the Russian economy and hurting the western economies. The only way to understand Biden’s policies is to realize that they are meant to cripple America, not help America. Unless people wake up, by 2030 we will own nothing and be very unhappy! We have to look behind the mask of perception and see the villain behind the mask! Putin is not the enemy!!
      God bless,
      Ken

      Like

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