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A Reader Asks “Does an Increase in Money Supply Cause Inflation?”

This seemingly simple question, is not so simple. What is the money supply? How does one measure inflation.

Other Deposit Liabilities vs M2, monthly average via St. Louis Fed

ODL vs M2 Chart Notes

  • Other Deposit Liabilities (ODL see description below), is a monthly average.
  • M2 is a monthly measure through March.

A Better Definition of Money

The main difference between ODL and M2 is that ODL does not include currency or retail money market funds.

Currency is accepted at an increasingly fewer number of business establishments and simply cannot be used for very large sized transactions. Retail money market funds never became an important medium of exchange. Both are becoming a far less used medium of exchange.

ODL has the additional advantage that it is the main source of funding for bank loans and investments, making ODL both a monetary and credit aggregate. Friedman would not be surprised that the need to change the best definition of what constitutes money would change over the years.

The above three paragraphs from Lacy Hunt at Hoisington Management.

Whether or not one uses M2 or ODL, money supply has generally been decreasing. Why the Fed cannot release M2 more timely is a mystery. It’s July 15, but the latest M2 is for May. One might wonder “What the H is the Fed hiding?”

Definition of Inflation

Some Austrian economists would say increases in money supply do not “cause” inflation, it is the definition of inflation.

If you hold that view, then deflation is the opposite and we are in deflation now.

Some mean the CPI when they refer to inflation. Others, notably the Fed, think the Personal Consumption Expenditures (PCE) price index is the best measure of inflation.

The huge problem with both the CPI and PCE is that it does not include asset prices, especially housing.

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