Over the last 40-years, we’ve had an experiment in “what causes inflation?” One suggestion is that the “too much money” part of the “too much money chasing too few goods” usual definition of inflation, comes about because of rapid wage growth. Too Much Money Chasing Too Few Goods and Services by Bill Bergman. Jul 17, 2021. 188 Comments Inflation can be considered a tax, an especially regressive one, falling harder on those with lower income and/or assets. By making money more expensive to borrow, the Fed effectively removes some of the excess capital from the market. Too much money chasing too few goods is one classic definition of inflation. Taking money out of the market slows the cycle of price increases. It is also defined as `too much money chasing too few goods’. Bare-boned, it means that a country is capable of producing only 100 items but the demand is for 105 items. It’s a very simple demand-supply issue. The more demand there is, the costlier it becomes. Much the same as the way real estate in the country is rising.

Fall 2011

For several years, a heated debate has raged among economists and policymakers about whether we face a serious risk of inflation. That debate has focused largely on the Federal Reserve — especially on whether the Fed has been too aggressive in increasing the money supply, whether it has kept interest rates too low, and whether it can be relied on to reverse course if signs of inflation emerge.

But these questions miss a grave danger. As a result of the federal government's enormous debt and deficits, substantial inflation could break out in America in the next few years. If people become convinced that our government will end up printing money to cover intractable deficits, they will see inflation in the future and so will try to get rid of dollars today — driving up the prices of goods, services, and eventually wages across the entire economy. This would amount to a 'run' on the dollar. As with a bank run, we would not be able to tell ahead of time when such an event would occur. But our economy will be primed for it as long as our fiscal trajectory is unsustainable.

Needless to say, such a run would unleash financial chaos and renewed recession. It would yield stagflation, not the inflation-fueled boomlet that some economists hope for. And there would be essentially nothing the Federal Reserve could do to stop it.

This concern, detailed below, is hardly conventional wisdom. Many economists and commentators do not think it makes sense to worry about inflation right now. After all, inflation declined during the financial crisis and subsequent recession, and remains low by post-war standards. The yields on long-term Treasury bonds, which should rise when investors see inflation ahead, are at half-century low points. And the Federal Reserve tells us not to worry: For example, in a statement last August, the Federal Open Market Committee noted that 'measures of underlying inflation have trended lower in recent quarters and, with substantial resource slack continuing to restrain cost pressures and longer-term inflation expectations stable, inflation is likely to be subdued for some time.'

But the Fed's view that inflation happens only during booms is too narrow, based on just one interpretation of America's exceptional post-war experience. It overlooks, for instance, the stagflation of the 1970s, when inflation broke out despite 'resource slack' and the apparent 'stability' of expectations. In 1977, the economy was also recovering from a recession, and inflation had fallen from 12% to 5% in just two years. The Fed expected further moderation, and surveys and long-term interest rates did not point to expectations of higher inflation. The unemployment rate had slowly declined from 9% to 7%, and then as now the conventional wisdom said it could be further lowered through more 'stimulus.' By 1980, however, inflation had climbed back up to 14.5% while unemployment also rose, peaking at 11%.

Over the broad sweep of history, serious inflation is most often the fourth horseman of an economic apocalypse, accompanying stagnation, unemployment, and financial chaos. Think of Zimbabwe in 2008, Argentina in 1990, or Germany after the world wars.

The key reason serious inflation often accompanies serious economic difficulties is straightforward: Inflation is a form of sovereign default. Paying off bonds with currency that is worth half as much as it used to be is like defaulting on half of the debt. And sovereign default happens not in boom times but when economies and governments are in trouble.

Most analysts today — even those who do worry about inflation — ignore the direct link between debt, looming deficits, and inflation. 'Monetarists' focus on the ties between inflation and money, and therefore worry that the Fed's recent massive increases in the money supply will unleash similarly massive inflation. The views of the Fed itself are largely 'Keynesian,' focusing on interest rates and the aforementioned 'slack' as the drivers of inflation or deflation. The Fed's inflation 'hawks' worry that the central bank will keep interest rates too low for too long and that, once inflation breaks out, it will be hard to tame. Fed 'doves,' meanwhile, think that the central bank can and will raise rates quickly enough should inflation occur, so that no one need worry about inflation now.

All sides of the conventional inflation debate believe that the Fed can stop any inflation that breaks out. The only question in their minds is whether it actually will — or whether the fear of higher interest rates, unemployment, and political backlash will lead the Fed to let inflation get out of control. They assume that the government will always have the fiscal resources to back up any monetary policy — to, for example, issue bonds backed by tax revenues that can soak up any excess money in the economy. This assumption is explicit in today's academic theories.

While the assumption of fiscal solvency may have made sense in America during most of the post-war era, the size of the government's debt and unsustainable future deficits now puts us in an unfamiliar danger zone — one beyond the realm of conventional American macroeconomic ideas. And serious inflation often comes when events overwhelm ideas — when factors that economists and policymakers do not understand or have forgotten about suddenly emerge. That is the risk we face today. To properly understand that risk, we must first understand the ideas underlying our debates about inflation.

THE KEYNESIANS' CONFIDENCE

The Federal Reserve, and most academic economists who opine on policy, have an essentially Keynesian mindset. In this view, the Fed manages monetary policy by changing overnight interbank interest rates. These rates affect long-term interest rates, and then mortgage, loan, and other rates faced by consumers and business borrowers. Lower interest rates drive higher 'demand,' and higher demand reduces 'slack' in markets. Eventually these 'tighter' markets put upward pressure on prices and wages, increasing inflation. Higher rates have the opposite effect.

The Fed's mission is to control interest rates to provide just the right level of demand so that the economy does not grow too quickly and cause excessive inflation, and also so that it does not grow too slowly and sink into recession. Other 'shocks' — like changes in oil prices or natural disasters that affect supply or demand — can influence the 'tightness' or 'slack' in markets, so the Fed has to monitor these and artfully offset them. For this reason, most Fed reports and Open Market Committee statements start with lengthy descriptions of trends in the real economy. It's a tough job: Even Soviet central planners, who could never quite get the price of coffee right, did not face so daunting a task as finding just the 'right' interest rate for a complex and dynamic economy like ours.

The Fed describes its recent 'unconventional' policy moves using this same general framework. For example, the recent 'quantitative easing' in which the Fed bought long-term bonds was described as an alternative way to bring down long-term interest rates, given that short-term rates could not go down further.

One serious problem with this view is that the correlation between unemployment (or other measures of economic 'slack') and inflation is actually very weak. The charts below show inflation and unemployment in the United States over the past several decades. If 'slack' and 'tightness' drove inflation, we would see a clear, negatively sloped line: Higher inflation would correspond to lower unemployment, and vice versa. But the charts show almost no relation between inflation and

Too Much Money Chasing Too Few Goods Real Balance Effect