The great inflation debate is likely to continue for some time.There are two schools of thought regarding inflation.
Monetarists believe inflation is a purely monetary phenomenon
Monetarists believe inflation can only be produced by expanding the money supply, at a faster rate than the growth of capacity output. Thus, at any given time, the actual rate of inflation is seen as reflecting current and past rates of monetary expansion.
“Monetarists believe inflation can only be produced by expanding the money supply, at a faster rate than the growth of capacity output”
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So when the economy is overheating, with inflation running unacceptably high, Monetarist argues inflation can be tamed by reducing M2. Monetary tightening can consist of the central bank reducing the size of its balance sheet, which is qualitative tightening QT, where the central bank sells assets.
QT causes asset prices to fall and is the wealth effect in reverse.
Central bank rate hikes are another type of monetary tightening, as the cost of servicing debt makes buying risk assets with leverage less attractive.
When the economy is in a recession Monetarists believe that easing can stimulate the economy, which is the inverse of tightening.
So central banks open the liquidity taps, with rate cuts and asset purchases, known as qualitative easing.
“When the economy is in a recession Monetarists believe that easing can stimulate the economy, which is the inverse of tightening”
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The inflation debate highlights the flaws with monetarism
During the post-2008 financial crisis, there was unprecedented easing up until recently. But economic activity remained unimpressive despite the massive easing, consumer spending was lackluster, and GDP failed to exceed a 5% boom.
But the Keynesian school of thinking enters the inflation debate with another view.
“The battle for world order is underway in a post-unipolar world. The hegemonic power either adopts the latest technologies or is superseded by a more advanced rival”
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Keynesianism focuses on government spending to control the economy and inflation
In other words, Keynesian believes that aggregate demand in the economy is driven by government spending and less so, by the change in the money supply.
So the Keynesian debate on inflation is that Frieden, an advocate of monetary theory, is wrong, arguing inflation is influenced by the money supply.
From the Keynesian school of thinking evolved the idea that economists should be more concerned about the money velocity, the rate at which money changes hands in an economy, rather than the money supply M2 level.
From here evolved the idea of Modern Monetary Theory, that M2 is no longer relevant in forecasting inflation, particularly since the velocity of money is in a terminal slowdown.
Fourth industrial revolution technologies make it increasingly difficult for humans to remain relevant in an advanced economy. The age of Automation and artificial intelligence is displacing humans from production at an alarming rate.
Moreover, the battle for world order is underway in a post-unipolar world. The hegemonic power either adopts the latest technologies or is superseded by a more advanced rival.
So it is no surprise where all Fed chairs sit concerning M2 in the face of inflation. We are witnessing an economic transition where domestic order is obtained with a universal basic income and central bank digital currency.
M2 will keep expanding.