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Long-time readers may already know what I’m going to say, but I feel the need to answer since Tyler Cowen asked the following:

"Let’s say more migrants arrive in a country.  One view, held by Bryan Caplan, is that (ceteris paribus) the monetary base is fixed, so now the monetary base per capita has decline.  Thus immigration is deflationary.  There are more people and not more money, alternatively you could say that the demand to hold money has gone up.  (I am, by the way, blogging this with Bryan’s permission.)

"Another view, mine, is that the new immigrants shift out both the aggregate demand and aggregate supply curves, and the net effect can be either inflationary or deflationary.  Even given a fixed monetary base, M2 likely will go up, as for instance banks will find they have more desirable loans to make, for instance to the new arrivals.  Optimal reserve requirements and money multiplier variables are likely to change, so the fixed monetary base need not choke off a demand increase.

"Who is right and under which conditions?"

My first response is that immigration probably won’t impact inflation, as the Fed targets inflation at 2%. Thus the monetary base (and IOR) will be adjusted as needed to keep long run inflation at 2%. But what if we assume a fixed monetary base? Who’s right in that case?

I’d say that Bryan is probably correct in the long run. (And long run effects are presumably what we care about with immigration.) But Tyler’s reasoning is correct; immigration would likely provide a one-time boost to base velocity. Thus, at cyclical frequencies, you might very well get higher inflation. Think of it this way:

1. Suppose an extra 3 million immigrants per year permanently boosts trend RGDP growth by 1%. As a result, US real interest rates rise by 75 basis points.
2. Suppose that a 75 basis point increase in interest rates permanently boosts base velocity from 10 to 11.

In that case, with a fixed monetary base you get a roughly 10% one-time boost in NGDP (and inflationary boom) followed by a permanent reduction in trend inflation of 1% (due to faster RGDP growth).

In my view, we should not assume that the monetary base would actually be fixed, and the baseline assumption should be no effect on inflation due to monetary offset. But if the economy is currently out of equilibrium (as it is today), then more immigration might affect inflation in the short run.

Surprisingly, I suspect it might actually reduce inflation by boosting the economy’s supply side so much that the Fed can bring inflation down more easily without creating a recession. By that’s highly speculative, and you could also argue that it would trigger a Fed expansionary policy mistake by boosting the natural interest rate by more than the Fed estimates. If the Fed doesn’t raise rates, inflation would rise.

When thinking about the merits of more immigration, I’d put inflation near the bottom of the list of factors we should consider. Also, for what it's worth, high immigration Australia has generally had relative high base velocity, which fits the model.

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