The Connection Between Money-Supply Growth and Inflation | Mises Wire
Also an evaluation of cases when increasing money supply doesn't cause inflation. This link between the money supply and inflation can be seen in In a depressed economy (liquidity trap) this correlation breaks down. causal relationship between inflation and money supply on one hand and .. consumer price index (CPI), Money supply (M2) and real GDP. Many works treat . The fact that Vague could not find strong correlation between increases in money supply M2 and changes in the CPI does not prove much.
We structured our analysis in the following manner. We tested three different definitions of a period of high monetary growth in three ways: One, as a 20 percentage point growth in the ratio of the money supply M2 to gross domestic product GDP in a five-year period; Two, as a 60 percent nominal growth in M2 in a five-year period; Three, as a percent nominal growth in a five-year period. One, as a period of three consecutive years of inflation of five percent or more using the consumer price index or CPI ; Two, as a period of five consecutive years of inflation of five percent or more.
This produced six possible cases that we tested: For each of these six cases, we then reviewed the data for all 47 countries to see how many times high inflation followed high M2 growth, and how many times high inflation occurred that was not preceded by high M2 growth.
We considered high M2 growth to have preceded high inflation if the period of high M2 growth was immediately before the period of inflation or that period was coincident with the start of high inflation. So, for example, if a period of high M2 growth was recorded from towe considered it to have triggered a period of high inflation if that high inflation period started at any point from to We found that in none of these six cases was high M2 growth a reliable predictor of inflation.
Our results were as follows See Chart 1.
M2 and inflation
In Case 1, there were 54 instances where M2 to GDP growth was at least 20 percentage points in five years. Only three of these were followed by a three-year period of high inflation and 51 were not.
By contrast, there were 49 instances of high inflation that were not preceded by high M2 growth. In Case 2, of 54 instances where M2 to GDP growth was at least 20 percentage points in five years, only one was followed by a five-year period of high inflation.
By contrast, there were 37 instances of high inflation that were not preceded by high M2 growth.
Cases 3 and 4, where high M2 growth was defined as a 60 percent nominal growth in five years, produced somewhat more positive results in that they were more instances of high inflation, and fewer instances of high inflation not preceded by this level of M2 growth. However, these results still fall far short of a level that could be viewed as causal or predictive since there are still a very large number of cases that do not lead to high inflation.
However, we found 43 instances where it did not lead to that level of inflation. In Case 4, high M2 growth was also defined as 60 percent nominal growth of M2 in five years, but inflation was defined as five consecutive years of 5 percent or more inflation.
High inflation occurred eight times when this type of M2 boom did not precede it. This is, of course, the opposite of what one would expect if high M2 growth causes high inflation.
In Case 5, we defined high M2 growth as percent nominal growth in five years, and high inflation as a period of three consecutive years of 5 percent or more inflation. Increasing the money supply faster than the growth in real output will cause inflation.
The reason is that there is more money chasing the same number of goods. Therefore, the increase in monetary demand causes firms to put up prices. If the money supply increases at the same rate as real output, then prices will stay the same. WIth the money supply increasing faster than output, there is a rise in nominal demand. In response to this rise in demand, firms put up prices and we get inflation.
The link between Money Supply and Inflation
Examples of increased money supply causing inflation This link between the money supply and inflation can be seen in many historical cases. In the aftermath of the First World War, Germany faced high reparation payments. To meet these demands, the government started printing more money — so that firms could continue to pay workers.
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- Rapid Money Supply Growth Does Not Cause Inflation
This led to an explosion in the inflation rate. By the end ofprinting money had got out of hand, and the economy experienced hyperinflation.
Zimbabwe found itself in a similar situation. High government debt, falling output and a need to print money to stave off a short-term crisis. Why increasing the money supply does not always cause inflation 1.
M2 and inflation | Econbrowser
In other words, the growth of money supply is absorbed in the increase in real output. Hard to Measure Money Supply. Sometimes the money supply is hard to calculate and is constantly changing.