US Core CPI is expected to have grown by 0.3% in April. Anything higher may trigger greater volatility as businesses and households fear rising inflation in the months ahead.
When the COVID-19 pandemic triggered economic recessions around the world, many businesses were forced to shut their doors. To help businesses and households navigate the unprecedented crisis, central banks and governments eased both monetary and fiscal policies. Central banks moved first, slashing the interest rates to zero or even into negative territory. Moreover, central banks created new money by starting massive quantitative easing programs, which are still running in the developed world.
Governments doubled down. They paid workers to stay home and even delivered checks directly to households, as was the case in the United States.
As a result, the M2 money supply grew at a rate not seen in more than a century. Also, the spread between M2 yearly growth and inflation increased to record levels. As the chart below shows, inflation eventually picks up with the growth in the money supply. Will it be different this time?
“Inflation” Ranks Higher on Google Search Trends
The money supply refers to the total quantity of money in an economy at one point in time. The M2 money supply is a broader measure than M1, in the sense that, besides checks or checking deposits, it includes savings deposits, money market securities and even mutual funds.
When the quantity of money in an economy rises, prices typically rise too. This is one of the reasons why, in normal times, central banks ease the monetary policy and even create new money to increase the money supply and, as an indirect effect, bring inflation to the target (typically around the 2% level).
Later today, the US Core CPI, which is the Consumer Price Index data that excludes food and energy, is expected to grow by 0.3% on an MoM basis. Previously, it grew at a similar rate. This is a monthly release, typically published about sixteen days after the month’s end.
The general public fears higher inflation, at least if the search term “inflation” on Google is anything to go by. It is trending because people see higher prices everywhere – commodities, equities, housing – and wages will follow when we see how hard it is for businesses to find staff.
Inflation is not a bad thing. In fact, it has been on every central bank’s mandate for the past four decades or so. Economists around the world agree that a certain level of inflation, away from the zero level but not far away from it, spurs economic growth. If inflation expectations are high, people spend faster and don’t postpone purchases, which in turn creates economic growth.
But excessive inflation is problematic. None of the principal central banks have had to deal with inflation during the last two decades, so will they know what to do when too much money is chasing too few goods…?