Category Archives: inflation

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.