Money Supply, Inflation and the Two-Year Lag

An excess money problem cannot be countered quickly

Letter to The WSJ.

"In his Nov. 4 letter, economist Paul Sheard makes three comments on our op-ed “The Monetary Bathtub Is Overflowing” (Oct. 22). They are all wrong.

Mr. Sheard’s first claim is: “If monetary growth was the cause of the inflation, real personal consumption numbers would be rocketing.” Incorrect. When monetary growth is excessive, nominal GDP (real growth plus inflation) rockets. This is exactly what has happened. The average year-over-year growth of nominal GDP for the second and third quarters of this year was 13.2%.

Mr. Sheard’s second claim is that “the consumer-price-index report reveals that big relative price shifts . . . and base effects lie behind the rise in inflation.” There have been big shifts in relative prices in the U.S., but also in Japan, China and Switzerland. Yet in these economies, overall price increases, measured by September’s year-over-year headline consumer-price index, are minimal: 0.2%, 0.7% and 0.9%, respectively. These inflation rates are low because money growth in these countries has been much lower than in the U.S.

Third, Mr. Sheard asserts: “If high inflation threatens to become persistent because the public’s inflation expectations shoot up, the Fed will counter with monetary tightening.” It is not the public’s expectations that cause inflation, despite much Federal Reserve and other rhetoric to that effect. It is the past growth of money that matters. Unfortunately, an excess money problem cannot be countered quickly. The lag between money growth and inflation is typically about two years. Therefore, even if the Fed counters immediately, it will take at least two years before the monetary bathtub stops overflowing."

John Greenwood

Chief economist, Invesco

London

Prof. Steve H. Hanke

Johns Hopkins University

Baltimore"