This morning we learned that the Consumer Price Index declined at a 0.2% annual rate in March for an increase of 1.5% over the past year. Last week we learned that the Producer Price Index declined 0.6% in March for an increase of only 1.1% over the past year. The latest GDP price deflator, for the fourth quarter of 2012, was up at a 1.6% rate, for an increase of 1.7% for 2012. No wonder that gold, that great hedge against inflation, is under pressure. Wile E. Coyote finally looked down.

What about inflation right around the corner? Inflation has been right around the corner for years now. Let’s look at money supply growth for a clue. According to the Fed’s H.6 series on the money stock, M2 growth was 6.8% over the past 12 months, 5.7% (annual rate) over the past 6 months, and only 1.7% over the past 3 months. This deceleration in money growth coincides with the Fed’s new round of purchases and balance sheet expansion under QE3.

What about velocity? Has an increasing velocity increased the “effective” rate of M2 growth? Or has a declining velocity decreased the effective rate of money growth? In our recent experience, it has been the latter. The moderate growth in M2 (moderate under the circumstances) has been rendered even more moderate by declining velocity. In fact, the decline in velocity has been about half of the percentage growth in money.

Of course, money growth plus velocity growth equals nominal GDP growth. So, we need not look further than nominal GDP growth to view the combined growth of money and velocity. During 2011 and 2012, nominal GDP growth was 4%. That is roughly composed of 7% money growth minus an average 3% velocity decline. What happened in the fourth quarter of 2012, our latest measured quarter? Nominal or current dollar GDP - the sum of money growth plus velocity growth - increased only 1.4%. Not a lot of inflation in the pipeline, I would say.

The story doesn’t change if we used different measures of the money supply since the velocity offset would be proportionally greater. For example, M2 growth of 7% minus velocity change of 3% yields 4% total spending growth or nominal GDP growth. If M1 grew twice as fast as M2, at 14%, then the decline in velocity (by arithmetic) would be 10 percentage points.

So far, I’ve been talking about the left side of the equation of exchange - MV. Four percent growth in MV must be matched (by arithmetic) by a 4% change in the right side of the equation - PQ - where P is the average price level and Q is real GDP. Roughly speaking, the division between price increases and real GDP growth has been half and half. Over recent years, on average, we’ve had a 2% real growth economy with 2% inflation. The inflation component seems to be coming down. It remains to be seen whether the real component will rise to fill the gap or whether nominal GDP will fall below 4% for an extended period.

People who are surprised by the low and declining inflation rate, or think the numbers are cooked, probably base their doubts on the fact that the Fed has been printing boatloads of money and rapid money growth always leads to rising inflation. The problem is that the fact is not a fact at all. The Fed has not been printing boatloads of money.