On Monetary Growth and Inflation in Leading Economies, 2021‐2022: Relative Prices and the Overall Price Level

In the United States and numerous other economies, we are witnessing a flood of ad hoc explanations for inflation. These deal primarily with supply chain issues that have arisen since the COVID‐19 pandemic and the reopening of economies. There is a widespread view among officials at the Federal Reserve System, economists in the Biden administration, academics, and even large parts of the business community that the current bout of U.S. inflation is largely the result of supply chain disruptions that will turn out to be “transitory,” and that the inflationary pressures will dissipate in 2022 as the supply chain issues are resolved. The authors argue that this consensus will prove to be wrong because of its failure to distinguish between relative price changes and changes in the overall price level. The movement of any single set of relative prices fails to convey information about the overall inflation rate. And as asserted by the Quantity Theory of Money, the overall inflation rate and price level are determined by changes in the money supply broadly measured. Changes in relative prices, on the other hand, result from changes in demand and supply in the real economy, making them independent of changes in the money supply. So, while a doubling of the money supply will result in a doubling of all nominal prices, relative prices remain unaffected by monetary policy. According to the authors, political pressure and a misguided faith in the benefits of monetary stimulus have led many governments and their central banks to produce excess money since the COVID‐19 pandemic started in early 2020. As a consequence, the authors anticipate that the U.S. and Israel are likely to see increases in their overall price levels of approximately 28% and 20%, respectively, over the next few years, whereas the U.K. will likely see an increase of about 11% in the overall price level. Meanwhile, for countries like China, Japan, Switzerland, and New Zealand that resisted the temptation to create excess money, the authors anticipate negligible increases in the rate of overall inflation.