Long and Variable Lags Between Money Supply and Inflation Dupes Economists

January 18, 2012


Money supply figures are growing at an alarming rate, and while the standard of living is eroding at a rate higher than government figures suggest, the pace of inflation has not been cataclysmic, yet.


The Fed uses a short-term outlook in their models, failing to account for the long and variable lead times between monetary manipulation and inflation, Fed historian and Carnegie Melon Professor Alan Meltzer notes. This myopic focus was on display in the 1970s. The US abandoned the gold standard in 1971: inflation hit Japan in 1972-73, then flowed back to the US, gathering steam throughout the stagflationary 1970’s, but failing to reach its zenith of an official 13% until December 1979 — 7 years later.

Bank of England Chairman Mervyn King studied the relationship between the growth in the monetary base and inflation for 116 countries from 1968-98. The 2-5 year correlation was not impressive; however, over periods like 5-10 years, “the correlations become almost perfect,” notes FT. “Over these longer horizons, the growth of the monetary base seems to be directly associated with the growth of both broad money and inflation. This association has been replicated in many other pieces of research, including this piece published by the Minneapolis Fed in 1995.”


For three straight years, the Fed has printed vast quantities of money, and is pining for more. This has sent inflation in China and other emerging markets soaring. Already, this has pushed up low end wages 20% or more in places, has caused a commensurate rise in food and energy prices, and has increased input costs for US manufacturers. The research supports an inflation surge in two to seven years, and a five year lag before it will be brought under control.  

Source: FT

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