The discussion about "transitory" versus "permanent" higher inflation is silly.

The point that the Federal Reserve has created a massive excess liquidity - broad money supply growths continue to strongly outpace the trend in money demand.

That is inflationary.

Have a look at the M3 of compared to a very long-term trend.

All that extra money will have to increase nominal spending in the US economy.

Higher nominal spending will cause the price LEVEL to increase as the output gap already has been closed in the US (Y likely is above Y*).

This will cause a PERMANENT increase in the US price LEVEL.

That doesn't necessarily mean permanently higher inflation in the US. But the money already printed by the Fed will cause a hop in price level. Whether INFLATION will be permanently higher dependent on FUTURE Fed policy.

A way of looking at the monetary "overhang" created by the Fed is to look at the so-called P-star model.

P-star is given by the actually level of broad money in the economy relative to the trend in money demand (real GDP and velocity)

I have calculated P-star using the CBO's measure of Y* and used the trend in velocity as a measure of V*.

So I do assume a continued downward trend in V.

I also assume that the monetary expansion is over and M3 from now on will grow at the same rate a in the 2010-2019 period.

Under this assumptions we can calculate the present and future P-star level. That's the blue line below. The orange line is the actual US price level.

Over time this gap (P-gap) has to close. I have here assume a fairly slow closing of the P-gap over +5 years.

If we make this assumption we will see inflation - here measured as the GDP deflator spike to nearly 10% by the end of this year.

And then gradually come down.

We could call this a "temporary" increase in inflation, but in this scenario inflation will remain well above Fed's 2% target for the next 5-6 years. That is hardly "temporary" in the normal sense of the world.

Alternatively if we assume that the monetary overhang will 'disappear' in two years time then the spike in inflation will have to be much bigger.

I have simulated that below.

In such scenario we are back at 2% in 2024, but inflation will be spike to above 18%.

I think this quite well illustrates that the discussion about "temporary" versus "permanent" is silly.

The case is that the Fed already have done the damage. The question is how fast it will play out. We will have no way of knowing.

But what we know is that the Fed consistently has down played the inflationary risks and that is worrying and I personally have a very hard time seeing the US economy just settling down in a nice 'steady state' with 2% inflation and stable real GDP growth in the near future

The monetary overhang simply is too large and we haven't in any way seen the impact of that on the US price level yet. We have seen it in stock prices and property prices, but a lot of prices haven't adjusted fully yet. That will happen over the coming years.

The question is what happens to the Fed's credibility in the process.

Fingers crossed the Fed (and the Biden administration) doesn't (continue to) repeat the mistakes of the 1970s.

/The End.

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More from @MaMoMVPY

29 Apr
1/n How much excesss liquidity has US monetary easing created? And how much inflation will it create?

The P-star model is a way to evaluate that.
2/n The P-star model is old-school monetarist thinking and was first presented in the 1989 in the article "M2 per unit of potential GNP as an anchor for the price level" by Jeffrey J. Hallman, Richard D. Porter and David H. Small

In the P-star model changes in inflation is explained by the difference between the actual price level (P) and what we could call the natural price level - or P-star - which is the implied price level given by the level of the broad money supply.
Read 41 tweets
21 Jan

I am working on a paper on why interest rates and yields are as low as they are. I will share some preliminary results here.

What I will share are some of the output from a simple model for US 10-year Treasury bond yields.

It is key to me that the model not only is statistically significantly, but is also economically significant. We need to understand economic developments within economic theory.
Read 51 tweets
1 Jan
I have been reading up on 'Central Bank Digital Currencies' (CBDC) - it seems to me that central banks really are mostly are driven by fear our 'private' crypto currencies and really have little idea about why they need CBDCs....
...I on the other hand think CBDCs could improve the functioning of monetary policy and could be useful in the conduct of monetary policy - particular with the natural interest rate close to the Zero Lower Bound.
In my view it would be better to talk about Central Bank Digital CASH (rather than Currency) indicating that it would be a digital version of non-interest rate bearing cash.
Read 35 tweets
29 Oct 20
1/n Siden marts har jeg brugt rigtig meget tid med Covid-19 data. I forhold til at forklare forskelle mellem forskellige lande er min konklusion at hverken adfærd eller politik betyder betyder nær så meget som det gøres til. Der er ikke ansvarlig og uansvarlige befolkninger.
2/n "Vi" styrer eller kontrollerer ikke virussen. Tidsmæssigt kan forskellige faktorer "forskubbe", hvor mange der bliver smittet og dør, men langt mere vigtigt er det, som jeg har kaldt "health fundamentals"
3/n de vigtigste health fundamentals er følgende:
1) Antallet af ældre (især mænd) som andel af befolkningen
2) Andelen af befolkningen, der er svært overvægtige
3) Andelen af befolkningen med mørk hud på den nordlige halvkugle
4) Sæson og klima (og dermed også verdensdele)
Read 22 tweets
21 Oct 20

Covid Scandale :

From the Danish newspaper @berlingske (in Danish):

"I ugevis har medier og forskere og over hele verden med stigende utålmodighed afventet offentliggørelsen af et stort dansk studie om effekten – eller manglen på samme – af at gå med mundbind i det offentlige rum her under coronapandemien."

"Nu kan en af de forskere, der har været involveret i studiet, oplyse, at det færdige forskningsresultat er blevet afvist af mindst tre af verdens absolut førende medicinske tidsskrifter."
Read 6 tweets
19 May 20
1/n Epidemiological vs economic forecasting

If we look at the forecasts we got from epidemiologists initially in this pandemic it has turned out that they have massively wrong. While tragic the number of people who has died in this pandemic has been much lower than forecasted
2/n The reason given by epidemiologists then is that that is because of interventions - lockdowns. But then you made the wrong kind of forecast - a forecast you forgot to forecast what would happen IF lockdowns were implemented.
3/n And how do you explain the numbers in South Korea, Taiwan and Japan? No lockdown and massively death told.

And Sweden with no lockdown, but with a death told/capita similar to other Western European countries (while larger than in the other Nordic countries).
Read 35 tweets

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