Inflation: Making The Complex, Simple - Part 1

Economists cite increasing oil prices as a driver for inflation and stronger retail sales from time to time. They assume consumers will still buy everything they were consuming, yet pay an extra $20 at the pump each week. In reality, consumers often substitute goods and services based on their budgets and needs. Economists often fail to consider the extra $20 spent at the gas pump is $20 not spent elsewhere.

The price of oil may rise, but the price of oranges may fall as consumers spend less on oranges to compensate. What matters most from a macroeconomic perspective is the aggregate price change for oil, oranges, Big Macs, and every other good and service.

To correctly anticipate inflation, we must look beyond the supply and demand for goods and services. The truth lies in the supply and the demand for money. Unfortunately, the supply of money gets the headlines, while its demand is an afterthought.

The chart below shows the forthcoming evidence of inflation used by most inflationists.

Inflation, Inflation: Making the Complex, Simple – Part 1

The following graph captures monetary velocity for an appropriate view of inflation.

Inflation, Inflation: Making the Complex, Simple – Part 1

Inflation is a function of money supply but equally critical, the demand for money (velocity). For more on why we must consider both, please read our article, The Fed’s Inconvenient Truth: Inflation is M.I.A.

>> Read Part 2: Inflation: Making The Complex, Simple 

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