October Inflation Slightly Improves: Time for Less Politics and More Policy

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Thank goodness the election is over. One of the frustrating parts of midterm season was that many people were more interested in how inflation would affect the election than they were in fixing the problem. That led to motivated reasoning and bad analysis from both parties. Now that the votes are in, maybe people will pay more attention to how inflation works, and how to fix it. That’s probably being too optimistic, but one can still hope.

October’s Consumer Price Index (CPI) numbers, released this morning, show a month-to-month increase of 0.4 percent, the same as September. Total inflation over the last 12 months is now 7.7 percent, down from 8.2 percent in September.

There is some good news is in October’s Core CPI number. This decreased from 0.6 in September to 0.3 percent in October, and is now lower than the standard CPI reading. Core CPI is calculated the same way as standard CPI, but it excludes food and energy prices, which are have volatile inflation-unrelated fluctuations.

Inflation is a monetary phenomenon. Over the last two years, the Federal Reserve grew the money supply by about 40 percent, while real output grew by only about 4 percent. That imbalance literally changed the exchanged rate between money and real goods—which is what inflation is.

The price of items like food and gas are increasing beyond monetary inflation for non-monetary reasons,  including supply chain problems, Putin’s Ukraine invasion, and restrictive energy and trade policies. That’s the bad news. The good news is that the Fed’s rollback of its excesses might be starting to take effect.

These things have long lag times that can vary widely. The Fed started a massive bond-buying program within weeks of COVID-19 arriving in America. It took about a year for all that new money to circulate from bond sellers through the larger economy and raise inflation. This delay, and its uneven effects, is called the Cantillon effect.

We may now be seeing Cantillon effects in inflation-fighting policies. The Fed stopped its bond-buying program in March of this year. As a result, the M2 money supply indicator has stayed roughly flat since then. The Fed has also raised the federal funds rate in steps several times this year, though it is still below the inflation rate, which means it is still causing some inflation on net, if less than before.

Seven months after these tightening measures began, they may be starting to show in the data. It is still too early to be sure, given the CPI’s noisy month-to-month variations and the uncertain nature of monetary lag times, but we are entering the window.

While the Fed is working to undo its policy mistakes, the political branches are making its job more difficult with massive deficit spending—and more of it likely on the way. Monetary factors affect inflation more strongly than do fiscal ones, so the Fed’s efforts should ultimately pay off, despite poor policy emerging from both ends of Pennsylvania Avenue.

Now that the election is over, hopefully people will be more open to learning that the money supply is the biggest factor affecting inflation, and that neither Republicans nor Democrats have much influence over it.

As I recently argued, politics and policy are different things. Politics is about zero-sum combat. Policy is about finding positive-sum solutions to problems like high inflation and other issues. Now that politics has had its big season finale, maybe people can pay less attention to politics and more attention to policies like binding the Fed to a policy rule to prevent future runaway monetary expansion or simplifying its dual mandate so it can focus solely on inflation.