Near-Term Consumer Price Inflation Risk Is Likely Low

Despite a record increase in the Money Supply (M2) the U.S. economy likely will not experience near-term consumer price inflation given less than robust Personal Consumption. Further expansionary monetary policy will increase price inflation risk, particularly if Personal Consumption continues to rebound.

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Figure 1. Weak Personal Consumption (a record 18% decline from peak to trough over 2 months) helped absorb upward pressure on prices exerted by the Federal Reserve’s massive increase in the money supply (M2). Click the image to enlarge or download.

Figure 2. Upward price pressure exerted by 18% M2 growth offset by an 18% Personal Consumption decline. Click the image to enlarge or download.

Figure 3. Here we have plotted Personal Consumption (the red line) against M2 (the blue line) from 2000 through June 2020. Notice how M2 increased during the 2008 financial crisis proportional to the decline in Personal Consumption. Inflation did not occur as weak Personal Consumption offset the upward pressure on prices. In similar fashion during the 2020 COVID crisis (as of June 2020) the Fed has increased M2 in proportion to the decline in Personal Consumption. It is unclear how much if any slack remains from a Personal Consumption standpoint that would allow the Fed to engage in further expansionary monetary policy without creating price inflation. Click the image to enlarge or download.

Figure 4. We plot M2 (blue line), M2 Velocity (green line), Inflation (red line) and Real Personal Consumption Expenditures (yellow line). Notice the inverse relationship between the Money Supply (M2) and M2 Velocity (the number of times an M2 currency unit is used to purchase domestic goods and services over a given period). Velocity is a ratio defined as GDP over a measure of the money supply. Personal Consumption is the largest component of GDP. Declines in Personal Consumption make it possible for the economy to absorb a certain level of M2 growth without necessarily suffering inflation. The Fed has expanded/(tightened) M2 as Personal Consumption has (tightened)/expanded. Click the image to enlarge or download.

Figure 5. We use the Quantity Theory of Money to explain figures 1-4. Click the image to enlarge or download.