Fighting inflation in leading economies: a medium term task

Last week, in an event organised by the IEA, my colleague from the IIMR, Tim Congdon, and myself stressed that annual money growth (broadly defined) must return to under 5% to bring inflation down to 2% a year. According to the latest monetary data available, the US, the Eurozone and the UK do not fulfil this condition. As reported by IIMR in its January 2022 money update (see table below), broad monetary growth in the US has accelerated in recent months, with an annual 9.8% rate of growth of M3, a figure well above that compatible with 2% price stability. In the Eurozone, monetary growth (M3) has also accelerated recently and is also too high (7.3% annual growth). The same applies to the UK (6.9% annual growth in broad money), though in this case the rate of growth of M4x has decelerated in the last few months.

Broad monetary growth world-wide

See IIMR January 2022 money update at https://mv-pt.org/monthly-monetary-update/

Here you will find two videos with our inflation forecasts for the US and the UK. In both cases, we use the quantity theory of money as the theoretical benchmark to make our analysis and projections of inflation for 2022- 2024. As Milton Friedman put it, there are “long and variable” lags between money growth and inflation. This is why, even if money growth fell to under 5% a year in the next few months, these lags mean that 2022, and probably 2023, will see inflation in the 5 per cent – 10 per cent area. This is because of the excess in money balances created in 2020 and 2021. Bringing inflation back to the central bank definition of price stability is a task for the medium term. Of course, ultimately the rate of inflation in the next two or three years will very much depend on the reaction central banks will take in the next few months to the current inflation episode.

We used this same approach in a report written for the IEA in the spring 2020 when Tim Congdon and myself anticipated an inflation boom in the US in 2021-2023. A key element in our analysis and forecasts is that changes in money velocity revert to their mean, as the data shows (see below the reversion to the mean pattern observed in the US in the last century). This means that the surge in the demand for money (and thus in money velocity) in 2021 will gradually cease as it has started to happen and eventually return to its 2019 levels, therefore pushing spending and prices up. More details in the presentation on the US below.

Castañeda, Cendejas, Congdon (2021). Presentation at IIMR 2021 conference. See https://youtu.be/cmhcLljq-Vk

The video presentation on the US inflation forecast comes from our contribution to the IIMR 2021 conference (“The 2020 money supply explosion and ensuing inflation”) and our comments on the UK from a recent interview we had with the IEA Head of Public Policy, Matthew Lesh.

Comments welcome.

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Are Member States in the Eurozone converging since 1999? And how different the trend is as compared to that in the UK and the USA?

These are some of the main questions addressed in a paper just published in the Journal of Policy Modeling, written with my colleague Jose Luis Cendejas (Universidad Francisco de Vitoria, Spain).

Title of the paper: ‘Macroeconomic asymmetry in the Eurozone before and after the Global Financial Crisis: An appraisal of the role of the ECB’.

Abstract:

‘The launch of the euro in 1999 was assumed to enhance macroeconomic convergence among EMU economies. We test this hypothesis from a comparative perspective, by calculating different indices to measure the degree of macroeconomic dispersion within the Eurozone, the UK and the USA (1999–2019). We use common factor models to produce a single index for each monetary area out of different measures of dispersion. These indices can be used to inform on the degree of optimality of a monetary area. Our results show that macroeconomic dispersion in the Eurozone increased notably even before 2007 and it took significantly longer to return to pre-crisis levels, as compared to the UK and the USA. The paper shows the critical role played by the ECB’s asset purchases programmes in reducing macroeconomic divergences among EMU member states since 2015.’

Fig. 1. Overall indices of dispersion for the Eurozone, the UK, and the US. 1999 = 100. The higher the figure the higher dispersion is. You will find individual dispersion indices for 12 macroeconomic and monetary indicators for each economic area in the paper.

The paper can be accessed freely on the following link for the next 50 days: https://www.sciencedirect.com/science/article/pii/S0161893821001009?dgcid=author

Comments and feedback most welcome.

Juan Castañeda

PS. Special mention to Professor Pedro Schwartz, with whom I started to work in this area years ago and have published on the topic before (see here and here).

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