An Inflation Indicator To Watch, Part 3

Notice also that core inflation jumped above the Fed’s current 2% target at some point during every expansion. In other words, core inflation can be volatile regardless of the circular-flow indicator’s direction. In fact, recent trends in monthly data place core CPI inflation above 2% again by spring or early summer, and core PCE inflation could follow. I mention this because I don’t want readers misinterpreting the charts above, which don’t preclude inflation continuing to fuel financial volatility as during the past month.


More to the point, the indicator bears watching as investors wonder if the recent inflation scare will be contained. It isn’t the only way to evaluate inflation risks, but there’s much to recommend it. I would say it fits the data like caroling fits Christmas, it’s as logical as giving thanks on Thanksgiving, and it supplies information not included in traditional indicators—like Groundhog’s Day but without the nonsense.

And that’s not all—the circular flow analysis I’ve proposed can also shine a cold light on stories told by mainstream economists. I discussed two of those stories earlier in this article—the Monetarist story and the story of central bank omnipotence—and I have a few concluding comments on each.

Monetarism. As discussed in Part 1, Monetarism enjoys nowhere near the popularity it reached in the late 1970s, despite a small tribe of modern-day descendents who continue to fixate on monetary aggregates such as M2. In my opinion, the 1970s Chicago Monetarists were like the 1990s Buffalo Bills—that is, they came oh so close. (Did you think I was going to call them wide right?) They had plenty of research proving the importance of money creation by banks, but they chose to preserve the mainstream narrative that banks are conduits, not creators, of the “initial monetary impulse.” If all of their eggheads hadn’t crammed into the same M2 basket, their popularity might not have fizzled out as it did.

Not only that, but circular-flow analysis such as mine would be standard fare if heterodox (and more realistic) thinking about money creation had forced its way into the mainstream before it became too late, shut off by powerful economists who built careers and reputations on orthodox theory alone. Again, 1970s Monetarism opened a window of opportunity but failed to climb through it—it was foiled by misconceptions about money and banking. (For a more thorough discussion on this topic, see my recently published book, Economics for Independent Thinkers, which applies circular-flow concepts to various issues in economics.)

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