It is generally understood that printing more money results in higher inflation. However, in the US (and the rest of the developed world) the printing press has been working overtime since 2008, but inflation has been consistently stubborn at bellow 2%.
Looking at increases in the money supply (the total amount of money in the economy), shows little correlation to inflation. This has been the case for decades. For example, consider the following two 4 year periods: the past 4 years, and the historical 4-year period with the highest inflation.
From Nov 2011 to Nov 2015 the money supply grew from 9.6 to 12.3 Trillion dollars, an increase of 2.7 Trillion, or 28%, yet core inflation was rather stable at around 2% over this period.
From Nov 1980 to Nov 1984 the money supply grew from 1.6 to 2.3 Trillion, an increase of 0.7 Trillion, or 43%. inflation over this period was between 8%-10%, peaking at 12% in 1984.
Assuming that the technical processes by which inflation is created worked similarly in these two time periods, then we can note the following:
1. Indeed higher percentage changes to the money supply can result in more inflation
2. Such increases are not linear. Inflation rates increased by more than X4, while money stock increased by lower amounts.
For inflation to rise, there needs to be more money available to a broad base of consumers. If more money is only available to a small group of consumers, the cumulative demand curve cannot move much, and therefore prices will not be pushed up. Indeed, inflation does show a strong correlation with median income. Increases in median income are followed by increases to inflation, with a lag of about 1-2 years.
Inflation will only go up 1-2 years after median income goes up.
Over the six year span 2008-2014 median family income only rose a total of 8.2% or an annualized rate of 1.3% per year. It should therefore be no surprise that inflation annualized to 1.6% over this same time period.
Inflation lags increases to median income. For inflation to rise, we need to see increases in median income, of over 2% a year for at least 2 years, and expect inflation to rise only the following year.
The Fed is looking at the wrong set of indicators for inflation. They are just waiting for some (any) glitch in the monthly CPI data, so that they can finally raise interest rates without having to face (overwhelming) criticism. It's not their fault. They are in an impossible situation. They are expected to fix all the problems in the economy using a very blunt tool that has little to no effect. Throughout all this, they are bombarded with criticism from all angles, including politicians who are steering towards the Fed both blame and responsibility for change.
How inflation works:
1. The money supply (M2) is increased, acting as a higher base for distribution.
2. Income distribution determines how this new money is divided. The more unequally it is distributed, the less it is translated into inflation. This distribution can be seen in the gap between the rise in M2, and the increase of median income.
3. Lagging between 1-2 year after increases to median income, CPI will follow by a comparable rate.