Why Monetary "Stimulus" Won't Prevent An Economic Bust

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The increase in the growth rate of the Consumer Price Index (CPI) has fueled concerns that if the rising trend were to continue the Fed is likely to tighten its interest rate stance. Observe that the yearly growth rate in the CPI climbed to 4.2 percent in April from 2.6 percent in March and 0.3 percent in April 2020.

We hold that because of massive increases in the money supply, it is likely that the growth momentum of prices is going to follow a rising trend.

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Note that the yearly growth rate of money supply climbed to 79 percent in February from 6.5 percent in February 2020. Various increases in the prices of goods are just the manifestation of increases in money supply.

Once money enters a particular market, this means that more money is paid for a product in that market. Alternatively, we can say that the price of a good in this market has gone up. Note that a price is the number of dollars per unit of something. 

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Hence, an increase in money supply, all other things being equal, implies that a greater amount of money is going to enter into various markets. This means that the prices of goods will follow suit.

Also, note that when money is injected it enters a particular market. Once the price of a good is rising to the level that is perceived as fully valued then the money leaves to another market, which is considered as undervalued. The shift from one market to another market gives rise to a time lag from increases in money and its effect on the average price increases.

Because of the time lag, the manifestation of the current strong increases in money supply in terms of the prices of goods is likely to become visible in the months ahead.

On account of the likely uptrend in the growth rate of the prices of goods in the months ahead we hold that the economic bust is going to emerge regardless of whether the Fed is going to tighten its interest rate stance or not. Here is why.

Money Supply and Liquidity

In a market economy, a major service that money provides is that of the medium of exchange. Producers exchange their goods for money and then exchange money for other goods. As the production of goods increases, this results in a greater demand for money. Conversely, as economic activity slows down the demand for money follows suit.

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