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Wildebeest is a PhD MBA who invests primarily in resource stocks such as base metals, iron ore and coal.
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  • Does a growth in M2 cause or imply an increase in inflation? 7 comments
    Oct 14, 2011 6:47 PM

    We've recently seen a growth in M2 in the USA. Should we expect a growth in M2 to lead to an increase in inflation?

    M2 and CPI data can be obtained from St Louis Fed:



    Here is a plot of growth in M2 and seasonally adjusted CPI

    Taking data back to the start of the M2 series in 1980 the equation of line of best fit is 3.14488 - 0.00672425 x and the data has an R squared of 0.000152817.

    For the USA there is no link whatsoever between M2 growth and CPI over the entire period of M2 data being published.

    Interestingly, visually the FRED chart looks to be showing an inverse correlation between the CPI and M2 growth from about 1996/97 through to 2010. Rises in M2 growth seem to coincide with falls in the CPI. That (negative correlation) is indeed the case, though weak, as the plot of data from that period shows:

    What of the possibility that inflation lags M2 growth? In other words isn't it reasonable to expect that as M2 growth increases the "surge" in inflation would be observed at some point later on rather than being coincident to the M2 growth?

    In the next plot I take a lag from zero to 120 months and measure the correlation (blue line slope, purple line r squared). We can see that a weak positive correlation begins to exist from a period of 45 months through to 90 months. Could we attribute causation to a correlation with such a long lag? Beats me, but I would have thought it was doubtful.

    I've also made plots of 12, 18, 24, 36, 48, 60, and 90 month rolling correlations. Here are a couple of samples:

    It seems to me that no case can be made that growth in M2 is likely to lead to an increase the CPI. On the contrary the data suggests if anything the reverse is more likely to be observed. Myth busted.


    Post script: it was put to me that it is not surprising that I am not seeing a relationship between M2 growth and the CPI because I am using headline CPI. So without further ado here are the charts using CPI ex food & energy.

    M2 growth and inflation? Nothing to see here. Move along.

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Comments (7)
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  • untrusting investor
    , contributor
    Comments (9903) | Send Message
    Interesting. Thanks for posting. Believe that inflation is not likely to be a real problem for at least the next few years, but could well become a significant problem later in the decade. Just looks like delevering could predominate for a few years yet, but eventually that will give way to credit expansion and inflation.
    15 Oct 2011, 11:13 AM Reply Like
  • Uchella
    , contributor
    Comments (21) | Send Message
    Ben and Jerry's, $3.49 three years ago at 7-11; Today $5.95 (LA prices). Real problem. What's the price curve on dinner at Morton's these days? Glad about the delevering from here though. Should investors EASE in here? Did you check out Scott O'Neil's article that I suggested?:


    15 Oct 2011, 02:26 PM Reply Like
  • untrusting investor
    , contributor
    Comments (9903) | Send Message
    Hmmmm, that's about 24%/year price inflation. Good thing B&J is not an essential item. Got to wonder when they will price themselves out of the market. Do know that would not pay that price for B&J.
    25 Dec 2011, 06:20 PM Reply Like
  • Dibber
    , contributor
    Comments (1375) | Send Message
    Just read this now. Appreciate this article a lot. As I've always thought about it, M2 is a better indication of money demand rather than supply. It's dominated by short term investment money/market type instruments, which balloon in principal amount when investor demand for money rises. I think that explains the negative correlation you see. mzm and other data series are better supply indicators.
    25 Dec 2011, 05:33 PM Reply Like
  • Conventional Wisdumb
    , contributor
    Comments (1800) | Send Message
    M2 is one part of the equation, the other is velocity.


    Inflation is a function of both and so it is not that surprising that expansion in M2 is not inflationary until it is combined with a rapid expansion in velocity.


    Velocity has been falling again as per St. Louis Fed:




    So in theory to "counteract" the deflationary effects of this the correct policy response is an increase in money supply which is what has been happening recently.


    Oddly it appears that the biggest risk we still face is deflation despite all the "money printing". If velocity takes off, I suspect the FED will panic and we will be back to the boom/bust economic cycle we had prior to the "Great Moderation".
    26 Dec 2011, 01:03 PM Reply Like
  • Dibber
    , contributor
    Comments (1375) | Send Message
    Velocity isn't independently measured. It's derived once you know M, P and T, so it isn't particularly useful. If someone knows how to measure it independently, would love to hear.
    27 Dec 2011, 12:45 PM Reply Like
  • Wildebeest
    , contributor
    Comments (778) | Send Message
    Author’s reply » correct. by definition if the money supply is expanding but the price level is not increasing as much then you have a velocity issue -- but this is circular because velocity, as you point out, is not measured independently.


    In any case the purpose of the article was actually in response to some hand wringing comments I had read about how inflation was about to break out DUE to the increase in M2. There is no reason to think that M2, on its own, will cause squat.
    2 Jan 2012, 05:40 PM Reply Like
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