The Washington Times: Gauging the Return of Inflation in a Post-pandemic America

Article by Richard W. Rahn in The Washington Times

Will inflation in the U.S. return in a big way? Inflation is a rise in the average price level, caused by an increase in the supply and/or velocity of money. 

If a central bank like the Fed increases the money supply at a faster rate than the economy is producing additional goods and services, inflation results — unless the velocity of money declines. Money velocity is the rate of turnover of the money in a given time period.

In 2020, the U.S. money supply by some measures increased by as much as 25%. If velocity had remained constant, the additional money would have resulted in a big increase in inflation.

When the economy was forcibly shut down in early spring, the U.S. Treasury at the behest of Congress opened the monetary spigots — in part, by sending checks to most Americans regardless of need in an attempt to preserve purchasing power — even though fewer goods and services were available.

The result was that most people increased their savings rate (reducing money velocity), and by saving rather than spending, inflation was avoided.

What will happen as the economy begins to return to normal as the pandemic subsides?

As restrictions on shops, bars, restaurants, travel, etc. are lifted, there will be big surge in demand for the previously restricted goods and services. The velocity of money will increase and over time should approach the long-term trend. 

In order to avoid inflation rising at a destructive rate, policymakers at the Fed, the administration and Congress will need to extinguish the excess money created during the pandemic at a rate to offset the rise in velocity.

Normally, this would require an increase in interest rates and a reduction in government spending.

But the folks at the Fed have said they do not plan on increasing interest rates, and it is difficult to imagine that Congress and the new administration will do anything even remotely serious about reducing spending.

The entire Washington establishment appears to have ....

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