More Money Supply, More Problems

Today’s chronic inflation has a wide variety of causes. Attention has been rightly focused on the pandemic, supply chains and stimulus programs. But the classic theory of money-driven inflation is worth a review, especially as the money supply reaches an inflection point.

The monetary theory always carried intuitive appeal: Holding all other factors equal, an increase in the money supply makes more money available for economic activity, leading to higher prices. In the past, we have noted that the monetary relationship is no longer reliable, especially in developed markets. Structural forces like globalization and technological advancements have helped to keep inflation in check. The notion that “inflation is always and everywhere a monetary phenomenon” seemed destined for the history books.

But then COVID-19 arrived. Governments launched massive stimulus programs to steer their populations safely through the pandemic. Central banks ramped up bond purchases to ensure liquidity. A financial crisis was averted as the world focused on the health risks and mitigation of COVID-19. But the surge of money in these efforts was massive. Since the COVID crisis, the money supply has grown by 40% in the U.S., 22% in the U.K. and 20% in the eurozone.