A new record: the monetary inflation starting in the US as far back as 2009/10 is still under way more than 15 years later. There has been no episode of serious monetary disinflation such as would create a meaningful intermission before the next monetary inflation. Under the fiat or hybrid fiat money regimes since 1914 the previous joint record for longest monetary inflation without break was 10/11 years, as in 1938-48, 1962-73 and 1995-2006. Typically, unbroken spells of monetary inflation have been shorter – including 1921-8, 1933-6, 1950-56, 1976-80, 1985-9, 1991-4.
There is no official institution, analogous to the NBER for business cycles, which dates episodes of monetary inflation and disinflation. The concept transcends simplistic characterizations based on the behavior of consumer prices. In real time economic commentators are prone to over-diagnose monetary disinflation just as they over-forecast recession. Most episodes of monetary inflation, especially the long and super-long ones, have featured harbingers of monetary disinflation which turn out to be false. Think of 1969 in the 1962-73 episode or 2000 in the 1995-2006 episode.
On both occasions there was considerable anxiety about stock market setbacks and economic weakness as triggered by Fed tightening; but the respective recessions as determined by the NBER at the time (December 1969 to November 1970 and March 2001 to November 2001) are no longer visible in revised data. The NBER, however, never reverses or amends business cycle determinations once made. In the present super long monetary inflation, false harbingers of a monetary disinflation include all the chatter about QE tapering in 2013, the Powell rate “normalization” of 2018 and the Powell “pivot” of 2022. By contrast the monetary disinflations of 1973-4 and 2006/7 were so powerful as to bring intermissions featuring both financial crash and great recession. And many contemporary observers underestimated (in real time) the severity of the 2006/7 monetary disinflation.
Understandably, given the length of the present super-long monetary inflation episode, there are people in the marketplace now wagering implicitly or explicitly that it will not end before “we are all dead”. Perhaps they are taking their cue from Kafka’s “The Trial”. There, the painter tells the accused man, Josef K, that his best realistic hope is indefinite postponement of judgement; a full acquittal never occurs. Could it be so with the present super long monetary disinflation? That would translate into indefinite postponement of monetary disinflation. But there would not be freedom from the oppression of the continuous trial – albeit with hearings postponed - and the eventual infernal outcomes would loom in present consciousness of many individuals.
Complacency about indefinite postponement of monetary disinflation would be surely on shaky ground. There may well be yet another troublesome episode of consumer price inflation which induces political pressure for monetary disinflation. And then there may be no last-minute stay of judgement from a coincident mega positive supply shock such as occurred in 2022H2-23. At that time a much faster than expected unwinding of pandemic dislocations meant that strong non-monetary disinflationary forces spared the Powell Fed from having to institute monetary disinflation. They could (falsely) claim success in reining CPI inflation back towards target without inflicting that pain.
Moreover, even without a recurrence of a CPI inflation spurt any time soon, monetary disinflation could occur unintentionally. For example, the Fed might judge that its path of policy rates is appropriate for monetary neutrality (neither tight nor easy). Yet in reality this path might prove to be highly disinflationary. Such error is highly probable at some stage in the future.
Applying the concept of monetary inflation or disinflation is now so treacherous given the corruption of the monetary system under the 2 per cent inflation standard regime. Base money no longer delivers a huge volume of intense monetary services – whether as medium of exchange or store of value. Government-backed contingency assistance to the banking system, payment and credit card oligopoly, and the war on cash have all led to a dilution of those services (The Qualities of the Monetary Base Essential to Sound Money: Fiat and Gold | Published in Quarterly Journal of Austrian Economics). At the critical margin of holdings, base money now renders no intense money services at all given that reserve deposits pay interest at the policy rate. Hence gone are the days when the continuous equilibrating of money supply and demand for money in real terms exerts potentially strong direct influence on markets for goods and services.
Instead, the influence of money on the economy comes most of all via fluctuations in interest rates. The authorities in seeking to exert monetary power focus on manipulating interest rates. Central bankers boast that they are piloting their policy rate on the basis of judging divergences between interest rates and the so-called neutral rate. But if truth be known, as sometimes even admitted by the central bankers, the concept of neutral rate is bogus.
Enter the concept of “data dependence”. Giving up on the possibility of diagnosing monetary inflation directly – either by assessing whether there is excess supply of monetary base relative to trend demand for real money balances or by whether interest rates are significantly and persistently below neutral – the Fed now diagnoses inflation by analysis of results. If there is persistent CPI inflation coupled with strong evidence of asset inflation, then bingo, there is monetary inflation.
Problems: Recorded CPI inflation is not an infallible indicator of monetary inflation – given the non-monetary forces can for considerable periods of time bring average price changes on an upward or downward trend even with no monetary disorder present. Asset inflation is also not always easy to diagnose with high confidence. And both goods and asset inflation occurs with a variable and potentially large lag behind the original monetary impulse, whether on the way up or down.
Bearing all this in mind how near could the US now be to a period of serious monetary disinflation? We should consider first, the extent of fragility (economic and financial) built in as a consequence of the 15 years of monetary inflation so far; and second, the the knock-on effects to monetary policy of the Trump Administration’s trade policies. All of this is in the context of well-known fiscal solvency issues.
Trade policies have set off a supply shock for the US economy. This emits non-monetary forces which put upward pressure on some prices of goods (most of all imports and goods produced in the US which are close substitutes for those imports). In a sound money system with its essential property of a solid anchor those price spikes would encounter monetary forces in the opposite direction. Individuals finding themselves short of super-money services due to the erosion of the base money holdings in real terms by price gains would cut back their intended expenditures (on non-monetary goods and services). There would also be a rise in money interest rates reflecting the shortage of base money.
Back to the real world, the Fed’s intention is apparently to pilot the policy interest rate taking account of augmented uncertainty and its potential to weaken the “demand side” of the economy. With consensus CPI inflation forecasts for end-year at 3-4%, its policy rate in real terms is now under 1%, which it would not judge as restrictive or indicative of monetary disinflation. Suppose that contrary to present Fed assessments, its broadcast policy rate path turns out to be consistent with a disinflationary process. The surprise could be due to materialization of endemic fragilities coupled with the negative psychological impact of trade war. As of now, though, asset inflation remains robust it seems, even though there are some doubts related to weakness in some residential real estate markets, in the fine art market, and some pull back in the previous bubble conditions in private equity.
Fiscal policy also is a factor in these inflation diagnoses. With a third of outstanding US government debt in floating rate form (maturities of less than one year) there is strong incentive for the Fed to visualize a lower than otherwise path for its policy rate. If mistaken – and the path proves to have been too low for too long) -at least there will have been some write-down in real terms of the government debt and even fall in debt to GDP ratios. Welcome to the notorious workings of inflation tax collection.
Bottom line: The absence of present money market rate rises in the context of trade supply shock accompanied by labor supply shock (tighter enforcement of immigration controls), all suggest that the Federal Reserve continues to administer injections of monetary inflation. Central banks outside the US, in Europe and Asia and Latin America, are simultaneously administering monetary injections, but in response to demand shock – weakening export demand due to US tariffs- rather than a supply shock. CPI inflation shock correspondingly would be a greater near-term threat in the US than elsewhere. Meanwhile asset inflation would remain alive and even virulent both in the US and globally.