Money and inflation
It's hard to be associated with the Federal Reserve and not think about monetary policy. The issue comes up ten times a year. I have more than this passing interest in it though. I've been interested in monetary policy ever since I first learned about monetary policy in finance classes — Strange place maybe, but who's to say? — when I was an undergraduate.
There are three sets of papers here. One group of papers examines the relationship between money and inflation.
Another group of papers examines the federal budget. The situation in the late 1990s is best summarized in my colleague Rik Hafer's words as “The Phantom Budget Surplus.” The surplus came and went and no one other than “policy wonks” noticed. Unfortunately, the situation today is so far the reverse that it would have been hard to imagine today's deficit then.
Last and not least, I wrote a piece on “Milton Friedman as a Teacher” that was published in a book with articles by his students.
Money and Inflation
I have written a few papers on the relationship between money growth and inflation. Is there such a relationship and is it likely to be useful to central bankers?
Two fairly readable papers on money and inflation were published in Reserve Bank reviews. The more recent paper ”Are Money Growth and Inflation Still Related?” was published in the Federal Reserve Bank of Atlanta Economic Review. In this paper, Rik Hafer and I examine the relationship between money growth and inflation using data for selected countries for a hundred years and data for about 80 countries for five-year periods. We find a substantial relationship.
An earlier paper on the same lines with Rik asked: “Is Money Irrelevant?”. This was published in the Federal Reserve Bank of St. Louis Review. The answer is: No.
I have written a couple of more technical papers on money and inflation. The most recent paper is “Inflation and Monetary Regimes” with Mark Fisher. We examine why the relationship between money and inflation appears to be closer when 1. high-inflation countries are included; and 2. the data are averaged over longer periods. Mark and I provide a single explanation for both observations. We suggest that long-term variation in the supply of money increases in importance compared to short-term or transitory variation in the demand for money when high-inflation countries are included and when data are averaged over longer periods. We also provide some evidence for this explanation.
An earlier paper tries to answer the question “Is Money Growth a Leading Indicator of Inflation?” I use quarterly data for the United States in a vector autoregression to examine whether complete neglect of money aggregates in monetary policy is justified. It is not; money growth helps to predict inflation. Conclusions to the contrary around the data of publication, 2002, may be due to the high short-term variability of money growth and the low short-term variability of inflation. A version of this paper was published as “Money Growth and Inflation in the United States” in the book Monetary Policy and Taiwan's Economy published by Edward Elgar Publishing Limited in 2002.
Budget Deficits and Inflation
The basic messages of my research on the U.S. federal goverment budget since the early 1980s are:
Government deficits are of secondary importance.
Government spending and taxes are very important.
Inflation is little affected by government deficits.
The results of an earlier analysis are summarized in the heading for this section. It may be hard to imagine a budget surplus given the federal government budget in 2009, but there was a fear of federal government surpluses not that many years ago.
The basic point is the same it was then. Government deficits do not necessarily lead to inflation; the history of the U.S. has been one in which they are not related. That does not mean deficits and inflation are always and everywhere unrelated. That is false. Zimbabwe is the current example of how false it can be.
Rik Hafer and I published a paper on “The Federal Government Budget Surplus: Cause for Celebration?” (with R. W. Hafer.) Federal Reserve Bank of Atlanta Economic Review 83 (Third Quarter 1998), 42-51. This is pretty old now, but it might be of interest.
The disappearance of the surpluses is not particularly surprising, nor is it a big deal. The changes in spending and taxes are a big deal. This observation is as true now as it was earlier in this millenium.