Category Archives: Monetary Theory

What Is Core Inflation?

The new inflation numbers are out, and they aren’t pretty. The Consumer Price Index (CPI) went up 0.3 percent during April, and is up a total of 8.3 percent over the last year. This is a slight improvement over last month’s 8.5 percent. More troubling is the core CPI reading, which increased 6.2 percent over the last year. What is this core inflation number, and why is it useful to know?

Core CPI is calculated the same way as standard CPI—take a hypothetical basket of goods and track their prices over time. The difference is that Core CPI removes the food and energy parts of the basket. The reason for this is that, contrary to popular belief, CPI doesn’t directly measure inflation.

Inflation is monetary; it has to do with the money supply growing at a different rate from real goods and services. The trouble is that non-inflation price changes are happening at the same time. These can be due to supply and demand shocks, changing tastes, seasonal patterns, and other factors. The CPI can’t tell how much of a price change is due to monetary inflation and how much is due to non-inflation factors like supply and demand. It just tracks price changes in a hypothetical basket of goods without asking what caused them.

Food and energy prices are notoriously volatile, which means that a lot of those changes have nothing to do with inflation. Grocery stores and gas stations change their prices every day. They can take enormous swings for reasons that have nothing to do with the money supply, such as Putin’s invasion of Ukraine or new regulations.

Taking food and energy out of the equation, as Core CPI and similar core inflation measures do, helps to keep the focus on inflation-related price increases. It isn’t perfect, because other goods are constantly subject to non-monetary price changes, too. But for those interested in tacking monetary inflation, core inflation is an improvement on the standard CPI.

It’s possible that inflation is at or near its peak right now. There is a lag time of up to a year and a half between the Fed’s monetary moves and their taking effect throughout the economy. The Fed increased the money supply by nearly $5 trillion during the pandemic, which caused most of the inflation we’re seeing now. The Fed stopped its big bond buy in March, and in June will begin slightly selling bonds. It will take some time before that shows up in any data.

Time will tell, but given that lag, it is possible we’re at or past the very worst of the current inflation, though it likely won’t significantly ease up until well into next year. Core CPI and other core-style indicators will help to give a more accurate picture of that process as it happens than will the standard CPI headline number.


Biden’s Inflation Speech: Top Domestic Priority

President Biden gave remarks on Tuesday declaring inflation his top domestic priority. Like many people, he seems not to understand that inflation is a monetary issue. Biden’s proposals each have their pros and cons, such price controls on insulin, antitrust action against the meat industry, and higher spending on renewable energy. But none of them have anything to do with inflation because they don’t have anything to do with the money supply.

Inflation is happening because the money supply is growing faster than real economic output. The Federal Reserve engaged in rapid money creation during the pandemic, and the result is today’s inflation. It will go back down once the Fed draws back some of that increase and money supply growth starts to better match the real economy’s growth. That’s on the Federal Reserve, not on Congress or the White House.

The political branches’ bipartisan deficit spending binge is likely responsible for a percentage point or so in the inflation rate, but one percentage point out of eight does little to explain today’s mess.

Biden does deserve some credit for the brief time he did discuss monetary policy. The Federal Reserve, not the political branches, runs monetary policy in the U.S. President Biden’s promise to “never interfere with the Fed’s judgment or tell them what to do” is a welcome change from his predecessor’s frequent public threats to Fed officials—assuming he keeps this promise. Some of his ideologically charged Fed nominees call into question his commitment to the Fed’s independence.

President Biden instead argued that inflation has two non-monetary causes: the pandemic and Putin’s war on Ukraine. Neither of these has much to do with inflation, because neither of them affects the money supply.

Biden then contrasted his own inflation plan with Sen. Rick Scott’s (R-FL) Republican economic plan. Sen. Scott’s plan also has little to do with inflation. A text search for “Federal Reserve” throughout the Scott plan’s economic planks on its website turned up zero hits. Scott’s plan has little support even in his own party. It has zero chance of becoming law, even if Republicans retake Congress. But as Grover Norquist pointed out, Scott’s plan is a political gift to Democrats, so one understands why Biden kept invoking it. It’s smart politics.

You can see why many economists find today’s inflation speech a little frustrating. It wasn’t actually about the thing it was about.

Still, President Biden did say plenty about faster-than-inflation price increases in gas, food, and other goods that almost everyone uses. Again, the faster-than-inflation components of those price increases are not inflation. That doesn’t mean that those prices increases aren’t real or that they aren’t hurting family budgets. They deserve policy action. But they are separate from inflation, and should be treated separately. As I’ve written before and will write again, supply and demand changes are not inflation. If isn’t monetary, it isn’t inflation.

One of President Biden’s energy proposals is to make more ethanol to reduce the need for imported oil. However, he did not mention the tradeoff: higher food prices. Farmers have planted only a certain amount of corn this season (planting season is typically late April to early May). Diverting more corn to ethanol leaves less left over for food and livestock feed. The increased ethanol might shave a penny or two from the price of a gallon of gas, based on the amounts involved. The tradeoff is higher prices for meat and for any food made from corn, such as chips, tortillas, and many cereals and sweets.

To fight rising food prices (counteracting his ethanol proposal), Biden proposed an antitrust investigation against meat producers. Realistically, this is Biden looking tough while doing nothing. Considering the likely policy alternatives, that’s not necessarily a bad thing. Antitrust cases take years, and inflation will likely be long gone before any case is resolved.

Biden’s response to food prices should instead involve trade liberalization. When asked about ending the China tariffs after his remarks, Biden said, “we’re discussing it, and no decision has been made on it.” On the merits, that decision should have been made long ago. Tariff relief would lower, by an average of almost 20 percent, the prices of thousands of goods worth hundreds of billions of dollars, from clothing to medicine to electronics. Combine this with the Fed finally getting its monetary house in order, and Biden would have a substantial accomplishment to brag about—and even better, for political purposes, it would involve undoing one of his predecessor’s signature policies.

While Biden did point out the importance of ports and trucks in opening up supply networks, he offered no concrete proposals for liberalizing them. Dockworkers’ unions have long resisted automation, around-the-clock operations, and other improvements that ports in most other countries adopted years ago. Convincing unions to join the current century would be a good start, though this likely requires more political will than anyone in the White House or Congress currently has.

Biden would like to see more truckers on the road. That is an easier lift, since many of the obstacles are in Washington, and under Biden’s control. Good ideas there include lowering the federal age requirement for truckers down to 18, giving truckers more control over their own hours, and getting rid of the 220 percent tariff on truck chassis, which forces small owner-operators to pay more than triple the world price for one of their truck’s most important components. Biden did not mention these ideas, but they would help ease prices on many goods (though again, separately from inflation, because these don’t affect the money supply).

President Biden gave his speech in the first place because the public wants to see him doing something about the country’s problems. This is problematic even in good times. The president has little control over inflation, and most of his proposals harm more than they help, while leaving inflation unaddressed.

Even a serious liberalization agenda on trade, labor, and regulation would have only a small effect on taming inflation, because those policies wouldn’t affect the money supply. They would have substantial economic benefits and are worth pursuing, but it would be misleading to say they affect inflation.

President Biden is hardly alone in not knowing what causes inflation. But when your starting point is in error, there is a very good chance your policy conclusions will also be in error. There is plenty he can do to fight inflation-unrelated price increases, but aside from a glimmer of hope for tariff relief, few of those options appear to be on the table.

Fed Hikes Interest Rate: Bigger News on Bond Portfolio Mostly Neglected

The Fed this week announced a half percentage point hike in its federal funds rate. This is the right thing to do, but it will have only a small effect on inflation. Far more important is an announcement the Fed made the same day, but got far less coverage. It will finally begin winding down its balance sheet of government bonds in June. Buying and selling bonds is the Fed’s single most powerful inflation-adjustment tool, far more powerful than interest rate adjustments. It should have started selling off bonds months ago, but June is better than never.

Inflation (or deflation) happens when there is a mismatch between the money supply and real economic output. If one grows or shrinks, the other needs to grow or shrink by a matching amount, or there will be inflation or deflation. The Fed’s job is basically to play a matching game.

Buying bonds is how the Fed directly increases the money supply—which directly increases the inflation rate. When the Fed buys bonds, it pays for them with money that it newly creates. This new money then winds its way through the economy.

If the Fed wants to directly shrink the money supply—and directly reduce the inflation rate—it can sell bonds. The money it makes from the sales can then be retired from circulation. Interest rate adjustments, by comparison, have only indirect effects on the amount of money in circulation.

In ordinary times, the Fed should engage in some bond buying. If real economic output goes up by 3 percent, the money supply should go up by a matching amount to prevent deflation. Since the Fed has a 2 percent target inflation rate, the Fed would instead usually react to 3 percent growth, with a 5 percent money increase—3 percentage points to match real growth plus two extra percentage points to meet the Fed’s inflation target. (The Fed’s exact response should vary depending on other factors, but this simplified illustration tells the essential story.)

That is not what happened during the pandemic. The Fed’s bond holdings grew by 72 percent in three months, then grew some more. It was the largest bond-buying spree in the Fed’s history. The Fed’s bond holdings totaled about $4.1 trillion when COVID-19 hit in February 2020. Three months later, it was $7.1 trillion. It continued buying bonds until March 2022, and its portfolio now stands at $8.9 trillion.

The Fed’s announced selloff is modest in this context, and may not be enough to substantially reduce inflation when the lag time ends sometime next year. It will reduce its $8.9 trillion portfolio by $47.5 billion per month for three months, then $95 billion per month for an unspecified amount of time.

Winding down inflation comes with a risk of recession, which explains the Fed’s timidity, especially in light of last quarter’s GDP contraction. So, the Fed has its reasons, though they are not entirely convincing, considering the short-term and long-term pain that inflation causes.

Nor did the Fed’s initial buying spree come out of nowhere. When people stop spending money, the Fed’s typical response is to inject some new money into the economy as a form of stimulus. It can work in the short run, though usually with the tradeoff of some slowdown later on.

The trouble is that the Fed misread the situation during the pandemic. It wasn’t a typical recession. There was no financial crisis, housing bubble, or economic malady. A healthy economy shut down for a bit, then opened back up. The virus had to pass so people could safely open back up, and that’s it. The Fed used the traditional tools to fight a new battle, and that is the biggest driver of today’s inflation. Overspending by the political branches didn’t help, but that explains only about 1 percentage point of 8.5 percent inflation.

There is a lag time in bond-buying actions from about six 6 to 18 months, since it takes time for new money to move from bond sellers’ wallets out to the larger economy. The rise in inflation that began in 2021 was the result of the Fed’s 2020 bond-buying spree. Since the Fed isn’t trimming its bond portfolio until June 2022, even if inflation has already peaked, it will likely remain high at least until early 2023 and possibly longer, since the Fed’s more recent buyups haven’t yet worked through the economy, and the selloffs to counter them are both late and relatively small. Relief would come sooner had the Fed acted sooner and more boldly.

Despite last quarter’s GDP decline, economic output is already back to where it would have been if COVID had never happened. Because of today’s needless inflation, the Fed’s delayed response in fixing it, plus overspending and general policy bungling by Congress and two presidents, a recession that COVID couldn’t cause might happen anyway. While this week’s interest rate hike will get all the attention, the real news is the Fed’s coming bond selloff.

A subsequent post will explain why the federal funds rate has only a small effect on inflation, and why journalists and stock markets should pay less attention to it.

Podcast: Inflation

I was recently the guest on the Of Consuming Interest podcast, hosted by Shirley Rooker. We talked about common misconceptions about inflation and a few other economic issues. After we wrapped, the producer said I was “very understandable,” which is easier said than done in monetary economics.

The audio is here.

Inflation Rises to 8.5 Percent: Straining for Optimism

High inflation will likely be with us for a while, which means I’ll be writing a lot of posts like this. So, for the sake of variety, after this morning’s inflation news, I’ll try to put as optimistic spin on it as possible. Just keep in mind that today’s news is objectively very, very bad. The Consumer Price Index (CPI) increased by 1.2 percent during March, which annualizes to 8.5 percent inflation. This up sharply from February’s 0.8 percent month-over-month increase and 7.9 percent annualized rate. The Fed’s target inflation rate is 2 percent.

A small part of the CPI increase is due to the Kremlin’s invasion of Ukraine and the related energy supply shock. As I recently explained, supply shocks are not inflation. When the administration points to Putin to deflect blame from itself, it won’t be entirely wrong, but it will be exaggerating.

For one, energy is only 7.5 percent of the basket of goods that CPI tracks, or less than 1/12th, not nearly enough to push inflation as high as it is now by itself.

Second, while, the Putin oil shock is severe enough to show up in the CPI, that doesn’t make it inflation. It is extremely difficult to tease out how much of a good’s price rise is due to monetary inflation that affects all goods and how much is due to a supply shock that affects just one good (and its downstream uses). The CPI is not up to the task, which is one reason why the Fed no longer uses it.

One way to compensate for this is to use the Core CPI instead of the regular CPI index. This is identical to the standard CPI, but excludes food and energy, which have frequent inflation-unrelated supply shocks. This currently reads an annualized 6.5 percent. The Atlanta Fed also calculates a Sticky Price CPI based on a similar philosophy. Its most recent reading is 4.3 percent.

These are both better than the standard CPI’s 8.5 percent inflation rate, and likely more accurate, since they exclude supply-shock-prone goods. But the target inflation rate is 2 percent, and inflation is still at multi-decade highs by any measure.

The second piece of (kind of) good news is that the Fed can get inflation back to its target 2 percent level very quickly. Congress and President Biden have not been helping with their multi-trillion-dollar deficit spending spree, which will likely add a percentage point or so to the inflation rate for as long as the next decade. But that’s only one percentage point out of eight.

Most of the rest is on the Fed, which has been creating new money at a frantic pace in an attempt to stimulate the economy during the COVID-19 pandemic. This was not the right thing to do, since the economy was otherwise healthy, but this mistake is fixable. All the Fed has to do now is to slow money supply growth so that it matches growth in real economic output. It has the authority and the tools to do so.

That does not mean reducing the money supply in absolute terms. The money supply should still grow, which is an underappreciated point right now among inflation hawks. The money supply needs to grow at the same pace as the rest of the economy, but not slower than real growth, which would cause deflation. And not faster, which is what is causing today’s inflation, but as close a match as possible.

The Fed is able to quickly grow the money supply by buying large amounts of government bonds. It pays for these with new money it creates, which then spreads throughout the economy. The Fed can counteract this just as quickly by doing the opposite—selling government bonds. It can then retire from circulation the currency it receives from bond buyers.

The Fed seems to know this, and ended its multi-trillion-dollar COVID-stimulus bond buying program last month. It is also hiking the federal funds rate. This has smaller inflationary effects than the bond buying program’s direct money creation, but the federal funds rate has important psychological effects on the public’s inflation expectations. Many supply chain and investment decisions cover months and even years. Companies set their prices today in part based on what they expect inflation to look like over those periods. If the Fed credibly commits to getting its monetary house in order, companies will set their prices accordingly.

Expectations aren’t as important as the actual money supply, but they still matter for getting inflation back to Earth. Higher interest rates can play a positive role, despite their lack of oomph on attacking inflation directly. The Fed has indicated that it will continually raise the federal funds rate for at least most of this year.  

While it will take a few months for those changes to work their way through the economy, they bode well going forward, especially if the Fed ramps up its changes to the degree it should.

There is some reason for guarded optimism, if you look hard enough. On one hand, anything could happen with Russia and Ukraine, the Fed is being far too timid, and Congress and President Biden show no indication of reining in deficit spending. But on the positive side, supply shocks are not inflation, no matter what the CPI says. The Fed has finally started to do the right thing. These things take time to percolate through the economy, so inflation will likely remain at or near 40-year highs for a while, but we may be at or near the worst of it.

As Eric Idle sings in the crucifixion scene at the end of The Life of Brianalways look on the bright side of life.

Inflation and the Biden Budget

It is good that the Biden administration is beginning to take inflation seriously. However, there isn’t much that the president and Congress can do about it. Inflation has to do with the money supply, which is the Federal Reserve’s territory. The Biden administration’s tranche of trillion-dollar deficit spending bills will likely contribute a percentage point or so to the inflation rate for the next several years. That is small potatoes compared to the Fed’s runaway money creation, which is responsible for most of the rest of today’s 7.9 percent inflation rate. At least as far as inflation goes, those bills have not been catastrophic. But they have made the Fed’s job more difficult.

Congress and President Biden can make the Fed’s job easier by undoing some of that spending and restraining themselves going forward. President Biden’s proposed budget would not do that.

Its headline item, a 20 percent minimum income tax on the very wealthiest of taxpayers, would likely have no detectable effect on inflation. It would have a small impact on the deficit, while not addressing overspending, which is the deficit’s root cause. Its negative impact on investment would harm economic growth. This would actually increase inflation, though in this case the effect would likely be too small to be detectable.

There is one area where the Biden administration can have some positive effect on inflation. Economic growth is deflationary, an underappreciated fact. The money supply is currently growing faster than economic output—that’s inflation by definition. The goal is to have them grow at the same rate.

There are two ways to do this. One is to slow money supply growth to get it closer to economic output growth, which the Fed is starting to do. The other is to grow the economy faster, so it better matches that fast-growing money supply. Both sides of the equation matter.

Fed policy remains the most powerful inflation-fighting instrument; fiscal policy from the elected branches doesn’t even come close. But economic growth can help fight inflation, too—besides being good for its own sake.

Congress and the Biden administration should loosen never-needed occupational licenses, trade barriers, energy restrictions, financial regulations, permits, and excessive paperwork. The resulting increase in growth would help to ease inflation. It would not be an inflation cure-all. But an extra percentage point or two of growth would make the Fed’s job easier at the margin. More importantly, more growth would save and improve lives.

In Order to Counter Inflation, Federal Reserve Should End Bond Buying Spree

This press release was originally posted at

The Federal Reserve announced today it would raise benchmark interest rates by a quarter percentage point with the aim of counteracting the effects of inflation.

CEI Senior Fellow Ryan Young said:

“Inflation happens when the money supply grows faster than real economic output. The wider the gap, the higher the inflation rate. The Fed has by far the most control over the money supply, so fighting inflation is on its shoulders far more than on Congress or President Biden’s.

“The Fed should have started acting months ago to stem inflation. And it needs to take more action than raising the federal funds rate by a quarter of a percentage point. Its massive bond buying program is finally due to wind down this month, which has directly added several trillion dollars to the money supply. This has had more impact than its interest rate policy, which affects the money supply only indirectly.

“The Fed can ease fears of further inflation by credibly committing not to embark on another bond-buying spree, and continuing to raise the federal funds rate throughout the year. Inflation expectations play a role in how companies set their prices, so easing these fears by itself can help keep prices in check. Congress and President Biden can also help fight inflation by spending less. This would make life easier for both the Fed and taxpayers.”


Correcting a Couple of Inflation Whoppers

Over at National Review’s Capital Matters site, I have a piece pointing out that today’s high gas prices aren’t caused by inflation. They’re caused by a supply shock due largely to Putin’s unprovoked war with Ukraine. The reason is that inflation has to do with money supply, and supply shocks do not:

The increase in gasoline prices far exceeded the overall inflation rate. According to the St. Louis Federal Reserve’s FRED database, the average nationwide gas price was $3.37 per gallon at the end of January. On March 7, it was $4.10—a 22 percent increase. In February, the consumer price index for all goods, which includes gasoline, increased by 0.8 percent.

While the Fed can control the money supply, it cannot do anything about supply shocks. But that isn’t the only whopper making the rounds right now. Gas prices did not, as widely reported, set new record highs last week:

GasBuddy said on March 7 that gas prices would likely set an all-time high on March 8, but did not adjust for inflation. Students know to do this, but some professionals apparently do not. CNBC and The Hillreported GasBuddy’s numbers without pointing this out. USA Today mentions the error, but then carries on as if it didn’t matter. It does.

Going back to the FRED database, before now, the highest recorded nominal (not inflation-adjusted) gas price was $4.12 per gallon, in July 2008. Using the Minneapolis Fed’s handy inflation calculator, that would be $5.19 in 2021 dollars. With the inflation observed so far in 2022, it would be equivalent to $5.23 today.

Read the whole piece here.

Inflation Sets Another 40-Year High: Relief Is in Sight, with Caveats

Inflation set a new 40-year high in February. The Consumer Price Index (CPI) increased by 0.8 percent in February, which annualizes to 7.9 percent. This is up from January’s 7.5 percent, compared to the Fed’s 2 percent target. That was roughly what was expected. The Fed made no policy changes in February and the U.S. economy stayed on the same trajectory, while Vladimir Putin’s unprovoked Ukraine invasion of Ukraine sent oil prices skyrocketing. That alone counts for about a third of the increase.

That said, there are two bits of good news—kind of. The first is that in March, the Fed is finally expected to end its bond-buying program and begin raising the federal funds rate. They should have done that months ago, but better late than never. Once taken, these actions will slow money supply growth—especially ending the bond-buying program, which intentionally creates new money out of thin air. Since the Fed’s expected actions will take time to work through the economy, they will probably not show up very much in March’s numbers when those come out on April 12. There are other factors in inflation, but the Fed policy component is by far the biggest, and it is likely about to turn the corner.

The second bit of kind-of-good news is that part of the CPI’s February increase isn’t actually from inflation. Putin’s war has caused oil prices to skyrocket, and energy accounts for 7.5 percent of the CPI. The spike is enough to account for a third of the February CPI’s increase from January. Supply shocks are not inflation, since they have nothing to do with the money supply. Inflation happens when the money supply grows faster than real economic output. The current price spike, which is hopefully temporary, doesn’t have a thing to do with the amount of currency floating around. It isn’t inflation.

This non-inflation noise from supply shocks is one reason why the Fed stopped using CPI years ago. It instead uses the Personal Consumption Expenditure (PCE) index. The media continues to mostly use CPI, possibly because it typically comes in at a higher number and is more volatile, thus allowing for juicier news stories. Lawyers continue to use CPI in most contracts that contain inflation adjustments, as do government agencies when indexing salaries and penalties, which is why the Fed continues to calculate CPI.

Another way to adjust for supply shock effects is to use the Core CPI statistic, which removes volatile energy and food prices from the CPI basket of goods, but is otherwise identical. This less volatile number better captures how much prices increases are due to inflation, rather than to changes in supply and demand. These are very different things, though it can be difficult to tell which is which.

Going forward, the Fed should concentrate on getting the money supply back in sync with economic output. It should ignore the oil price shock, which is out of its control. Congress and President Biden can help reduce oil prices by repealing the Jones Act, which makes shipping domestic oil more expensive, and by removing obstacles to increasing the domestic supply. Russia accounts for about 1/30th of U.S. oil imports, which isn’t nothing, but also isn’t decisive. More liberal policies can help absorb some of the shock. But politically tempting illiberal policies, such as price controls and antitrust actions against energy producers, will only make things worse.

U.S. Economy Adds 678,000 Jobs in February, but Inflation, Russia, Government Mandates Remain a Problem

This press statement was originally posted on

The U.S. economy added 678,000 jobs in February, according to newly released government figures. CEI economic and labor policy experts praised the good news and cautioned against government spending and regulations that will hinder the recovery.

Ryan Young, CEI Senior Fellow:

“Once again, economic news has moved in step with the virus. Case counts and severity have been going down for weeks, so people are opening up more. And now authorities are loosening mask mandates and other measures. No wonder more people are going back to work. The virus is now on the edge of no longer being the most important economic indicator, barring any new variants.

“There are challenges ahead from inflation and from Russia’s invasion of Ukraine.

“The Fed will likely soon raise the federal funds rate and end its bond-buying program in order to fight inflation. Employers might react to this by decreasing hiring and investment somewhat until things stabilize. But the long-run benefits of stable prices will be more than worth it. 

“Vladimir Putin’s hubris will cause oil prices to rise for some time, but Congress and President Biden can help by repealing the Jones Act, which raises domestic shipping prices so much that it is often cheaper for refiners near coasts to turn to foreign oil instead, often Russian.”

Sean Higgins, CEI Research Fellow:

 “The continued decline in the employment rate, which fell to 3.8 percent in February, is further proof that the best remedy is to roll back the Covid pandemic restrictions and allow the economy to heal itself. The Labor Department reported Friday that only 4.2 million people were unable to work in February because their employer was closed or lost business due to the pandemic. That was down from 6 million who faced the same problem in January. That 1.8 million worker shift more than accounts for February’s overall gains of 678,000 jobs.

“New federal spending programs, minimum wage regulations, other government mandates aren’t needed to get us the rest of the way back to where we were in February 2020. We just need to put the pandemic behind us.”