Over the past few years, I’ve repeatedly emphasized Milton Friedman’s insight that central banks deserve blame for inflation.
To illustrate, here are two charts.
The first chart shows the Federal Reserve’s balance sheet. If you focus on the past five years, you can see that there was a dramatic increase in money creation by the Fed starting in the second quarter of 2020.
The second chart shows the annual inflation rate. Once again, focus on the past five years and you’ll see that prices began to rise in 2021, as the Fed’s excess money began circulating through the economy.
Looking at the two charts, you can all see that the Fed began to unwind its mistake, starting in mid-2022.
Lo and behold, shrinking the Fed’s balance sheet (i.e., soaking up some of the excess money) has now translated into a falling inflation rate.
I’ve provided this background because there’s now a controversy involving some left-leaning economists who signed a letter asserting that Trump’s economic agenda would be inflationary. Here are excerpts from the letter.
We the undersigned are deeply concerned about the risks of a second Trump administration for the U.S. economy. …Many Americans are concerned about inflation, which has come down remarkably fast. There is rightly a worry that Donald Trump will reignite this inflation, with his fiscally irresponsible budgets. Nonpartisan researchers…predict that if Donald Trump successfully enacts his agenda, it will increase inflation.
Here’s how Axios summarized the letter.
Are these economists correct?
Before I give my two cents, here are some excerpts from James Piereson’s article in the City Journal.
In 2021, 15 of these same economists…signed a similar public letter endorsing Biden’s Build Back Better agenda… Several pieces of a pared-back plan were eventually incorporated into the so-called Inflation Reduction Act of 2022… The prize-winning economists had this to say about Biden’s economic proposals: “Because this agenda invests in long-term economic capacity and will enhance the ability of more Americans to participate productively in the economy, it will ease longer-term inflationary pressures.” …How did it all work out? The expert economists were badly mistaken on inflation. They said that Biden’s spending packages would “ease inflationary pressures,” but everyone understands today that those same policies stoked inflation. …In sum, the Nobel laureates praising Biden’s policies today (and criticizing Trump) are the same ones who recommended policies that ignited inflation… Judging by their track record, when it comes to economic policymaking, these prize-winning economists have no idea what they are talking about.
I agree with almost everything that Piereson wrote.
The one exception is that it is wrong to have written that Biden’s “policies stoked inflation.” No, the Federal Reserve caused inflation.
Though, to be fair, the Fed may have pursued bad monetary policy because of “fiscal dominance.” To be more specific, the Fed expands the balance sheet by buying government bonds. Some speculate that the Fed’s motive for buying government bonds was to help Trump and then Biden to finance the spending orgy in Washington.
That being said, the Federal Reserve’s expansion of the balance sheet would still be the reason for inflation.
One final observation is that the leftist economists based their argument on Keynesian economic theory. From this warped perspective, inflation is not necessarily caused by excess money creation. Instead, it can be a consequence of excessive demand.
I think it’s possible we get inflation under Trump, but not for the reason they cite.
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Image credit: Elvert Barnes | CC BY-SA 2.0.