Milton Friedman’s posthumous comeback – NRC

Is the current wave of inflation temporary or long-term? That question is wrestling with policymakers, central bankers and ordinary people planning their summer vacation. It is difficult to answer: all kinds of variables are involved in the height and duration of the inflation peak. The cause of energy prices is obvious: they were, and will continue to have, an extra pendulum due to the high tensions surrounding Ukraine.

Shortages of all kinds of stuff, due to faltering transport and production chains and a strong wave of demand, are another factor. And tightness in the labor market is a third component, for the longer term. Economists of ABN Amro assumed this week that (potentially inflationary) wage increases in the Netherlands and the eurozone will be better than expected, but could become a significant factor in the Anglo-Saxon world.

You can also approach inflation from a completely different angle. Inflation, according to economist Milton Friedman, is “always and everywhere a monetary phenomenon.” In other words, if too much money comes into circulation, that money loses its value. And that is noticeable, because you can buy less and less with it. So inflation.

Friedman came up with his theory in the early 1960s, but only became fashionable in the 1970s when inflation spiraled out of control: in 1976 he was awarded the Nobel Prize in Economics. The rise of Friedman’s ‘monetarism’, coupled incidentally with his ultra-liberal convictions, left its mark. In the 1980s and 1990s, German monetary policy focused, entirely in Friedman’s mind, on the development of the money supply, the so-called M3 – where M stands for ‘money supply’ and 3 stands for a broad definition of it.

At the time, US money policy steered towards a slightly narrower definition, M2. They threw that overboard again in the late 1980s. The German Bundesbank merged into the European Central Bank in 1998. M3 initially became one of the pillars of monetary policy, but has completely faded into the background in the first ten years of the euro.

One of the consequences has been that the money supply in the eurozone has continuously grown faster than the (nominal) economy itself since the introduction of the euro, and that nobody took offense. And why too? Inflation remained under control and was too low rather than too high after the 2008 financial crisis.

The result is that, for the first time in (known) history, there is now more money in circulation in the eurozone than the size of the economy itself. That is unprecedented. It follows from economic theory that the only reason that – until recently – there was hardly any inflation, is that the velocity of money must have decreased drastically. In other words, there seems to be a huge sea of ​​money somewhere out there that doesn’t do much. The excess money supply looks a bit like what dark matter is for astronomers: in theory it should be there, but cannot be observed. Or are we witnessing a monetary levee breach?

Martin Wolf, the home economist of the Financial Timesdedicated this week a big part of monetarism† The IMF wrote, also this week, a critical piece on the use of unconventional policies (the massive purchase of government bonds in exchange for money) by central banks.

Is Friedman’s theory making a comeback now that inflation is high and will remain so for a while? Friedman, because of his other ideas, has always been politicized. But it would be a shame to put him away for that. The current wave of inflation – also in the housing market – deserves further monetary research, preferably without ideology.

Maarten Schinkel writes about economics and financial markets.