![]() The problem, of course, is that central banks can only affect a subset of the causes of inflation. Finance-oriented people all have an opinion on what Federal Reserve Chairman Jerome Powell should be doing differently than he is at any given time. Critiques of current monetary policy have become a modern day form of Monday-morning quarterbacking. This has been one of the hot macroeconomic discussion topics over the past couple years. That being said, within the context of the existing financial system, what should central banks do when significantly above-target price inflation does happen? Policymakers are fine with the steady debasement of currency, and even desire it, but don’t want the rate of debasement to get out of control. Over the long arc of time, prices of things like oil and meat and gold and real estate have grown at a significantly faster rate than that, while the averages have been pulled down by certain deflationary categories such as electronics and textiles where massive productivity gains were made. Most central banks have a 2% annual price inflation target rather than a 0% inflation target. Technology also makes us more efficient at finding and extracting oil over time, up to a certain point. On average since 1913, only 1.5% more above-ground gold ounces exist per year, but 7% more broad dollars exist per year, and thus the price of oil tends to hold steady in gold terms but tends to appreciate in dollar terms. It has the same supply/demand fluctuations, but also has an exponential trend of price increases, because dollars have an exponential trend of supply increases and therefore persistent debasement: Here’s the price of oil in dollars since 1913. Periods of major recession or certain periods of peacetime abundance generally put oil in low demand relative to abundant supply, and cause low prices: Periods of great growth or major war generally put oil in high demand relative to scarce supply, and cause high prices. We can see that it fluctuates pretty wildly between 0.02 ounces of gold for a barrel of oil and 0.14 ounces of gold for a barrel of oil, but generally in a sideways pattern. Here’s a chart for the price of oil in gold since 1913. On the other hand, periods of technological improvements, labor specialization, the sacrifice of resiliency for efficiency, geopolitical and civic peace, and abundant natural resources tend to all contribute to the experience of disinflation due to their positive effects on the supply of goods and services.Ī useful example of this is to compare the price of oil in gold and in dollars over time. Periods of technological stagnation, societal dysfunction, the need for resiliency over efficiency, war, and scarce natural resources tend to all contribute to the experience of inflation due to their negative effects on the supply of goods and services. Periods of fast bank lending or large monetized fiscal deficits (and thus rapid money supply growth) tend to create inflationary environments, while periods of fiscal austerity and/or private sector deleveraging events (and thus slow money supply growth or outright money supply contraction) tend to create disinflationary or outright deflationary environments. ![]() ![]() In short, the rate of consumer price inflation in an economy comes from a combination of 1) money supply growth and 2) significant changes in productivity and/or resource abundance. ![]() In prior articles and newsletters, I’ve explored the causes of consumer price inflation over time.
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