Abbiamo discusso oggi con Davide Buccheri i recenti trend inflazionari.
“Una metrica interessante su cui di rado ci si focalizza è il rapporto tra PIL e M1” ha iniziato Buccheri.
“Intuitivamente, potremmo interpretare questa metrica come una misura del PIL reale” continua Buccheri. “E’ abbastanza chiaro, però, come questa metrica sia estremamente distante dai numeri ufficiali riportati per il PIL reale”.
Davide Buccheri ha poi spiegato come il valore della moneta non sia linearmente legato alla sua quantità. “Se ciò fosse vero, PIL/M1 sarebbe una buona approssimazione del PIL reale e M1 una buona approssimazione del CPI, ma questo non è semplicemente quello che osserviamo nei dati” continua Buccheri.
Inflazione e M1 nel lungo termine
“Il rapporto tra M1 e inflazione è estremamente importante, in quanto è il più chiaro indicatore di efficacia delle politiche monetarie” spiega Buccheri.
“La relazione tra le due variabili non sembra essere lineare” continua Buccheri. “Seguendo i dati, potrei dire con un certo livello di confidenza che la relazione sia logaritmica”.
“Questo è fondamentale per l’efficacia delle politiche monetarie nel lungo termine, in quanto una relazione log
Then inflation, π, will be the change in CPI with respect to M1:
The interesting thing about this is what happens when the money supply increases. In actual fact, we have that:
If the relationship we found is true, it implies that, in the long run, inflation will tend to zero.
Inflation and M1 in the medium term
But what does this mean over a shorter time period?
As we have estimated our function above, we can use it to predict what changes in M1 will be necessary to keep inflation at the current target of 2%.
The chart above shows the monetary change and percentage change that the money supply will need to experience each year, over the next 25 years, to keep inflation at 2%.
We can see that each year the money supply will need to increase by a greater percentage, compared to the year before, starting with a 7.1% increase and ending with an 11.7% increase. In monetary terms, this translates to an increase of US$ 3.6tn a year in 25 years from now, to keep inflation at 2%.
In particular, given our relationship, we will have that:
That is, the growth rate of the money supply will have to grow at the target rate of inflation, otherwise the Fed will either undershoot or overshoot its target.
Note that this trend has already been at play for years, but more erratically. The chart below compares the actual yoy growth rate of M1 and its trend (in blue), with our projections to keep inflation at 2% (in red).
It is possible to see how, historically, M1 has been on an even higher trajectory than what I project here. This can be ascribed to the higher average inflation rate of 3.76% during the period, compared to the current Fed target of 2%.
At this point, a necessary question is whether this accelerating growth rate can be sustained. In order to see this, we need to check the debt market.
Debt Market and Open Market Operations
Currently, in order to increase the money supply, central banks engage in so-called Open Market Operations (OMOs). In an OMO, the central bank buys existing securities, reducing their supply and releasing cash in the economy.
To understand whether the current monetary policy is sustainable, we need to understand whether enough debt securities are available on the market.
The chart below was compiled using data from BIS and shows the total level of debt securities in the US for the 1990 - 2019 period.
We can see how there’s been somewhat of a slowdown after the financial crisis. Since 2012, debt has been growing at around 3.4% a year, compared to 6% in the 1990-2012 period.
With this in mind, we can check what proportion of total debt the Fed would have to buy to keep inflation at 2%, assuming different growth rates for the debt.
We can see that even with the best assumptions, the Fed would need to buy around 2.1% of all outstanding debt each year to keep inflation at 2% in 25 years from now. At the current growth rate of debt, this would balloon to more than 3% (again, each year).
At first glance, these numbers don’t appear to be particularly large. However, to put this in context, from August 2018 to August 2019, M1 increased by US$180bn, or 0.4% of the total outstanding debt. If you think the Fed is currently disrupting fixed income markets, think about what will happen when that impact becomes more than 5 times greater.
It is clear how this policy would create significant market distortions in the medium term, displacing private investors. In addition, this policy is doomed to collapse after a few more decades, as the Fed would need to hold more debt than what debtors are ready to issue on the market.
On the other hand, if the Fed decided to grow the money supply at the same rate as debt, it would fail to meet its inflation targets. The chart below shows projected inflation for the next 25 years, assuming that M1 grew at the growth rate of debt.
Having established that OMOs are not a viable solution to keep inflation at 2% over the medium term, the last thing we need to consider is whether other alternative methods should be used (e.g. helicopter money).
GDP and M1
There are two solutions that immediately spring to mind: helicopter money and monetization of the fiscal policy.
As for the former, for this to become a necessity, the economy would need to be in so little need of cash that the Fed had to resolve to quite literally shove money at people’s faces. This does not seem to be a healthy way of generating inflation.
On the other hand, the monetization of public debt could be a more attractive option, allowing the government to borrow at extremely cheap rates and invest in infrastructure and other necessary projects. However, this goes completely against current monetary policy doctrine and could result in a displacement of private investments.
Although the Fed could probably manage to use these or some other methods to increase the money supply, the data seems to suggest that economy doesn’t need all of this excess cash. This can be seen by looking at the chart below, which compares the money multiplier (M3/M1), with GDP/M1.
This is a particularly interesting chart, as it shows that these two metrics have been closely related to one another in the past. This makes logical sense: if significant investment opportunities are available, companies and private consumers will first collect the cash, increasing M3, and then deploy these resources into profitable investments, increasing GDP.
However, what we’ve seen since the financial crisis is quite different: both M3 and GDP are declining, compared to M1. In addition, GDP is declining significantly more than M3. This seems to suggest that investors initially took advantage of the flood of cash in the economy, building some deposits, but without having any profitable investments available (which opened the gap between M3 and GDP). As time went by, no new significant investment opportunities seem to have arisen, which meant that there was no new demand for cash. This meant that both M3 and GDP started to decline at a similar rate, relative to M1.
This is a very strong indication that the economy doesn’t know what to do with all the available cash. This is a dangerous game, as the decline of M3 compared to M1 translates in a lower money multiplier: the Fed will therefore have less power to influence the economy during a recession, when it’ll need it most.
The data shows that a non-linear, logarithmic relationship exists between CPI and M1. This implies that, over the long-run, inflation should tend to zero.
The change in M1 needed to keep inflation at the current target of 2% is not sustainable through OMOs, as the Fed would have to buy more debt than what is available on the market in a few decades. Adjusting the growth of M1 to match the growth of debt would result in a significantly lower level of inflation of around 1% and slowly declining through time.
Other means of increasing M1 are available, but appear unnecessary, when looking at the trends of GDP and M3 compared to M1. In particular, it seems that there aren’t enough profitable opportunities to invest the gargantuan amount of cash available. This is causing a decline in the money multiplier through time, further eroding the ability of the Fed to influence the economy.
This trend is not necessarily a negative, if central bankers accept it and stop fighting it by injecting extreme amounts of cash in the economy. After all, the objective of monetary policy is to keep inflation stable and this trend implies that only extreme shocks would have the potential to move it significantly. Currently, that shock seems to be coming in the form of monetary policy.
A possible solution that would prevent deflation would be to increase the money supply to match the growth of debt. This should ensure a positive level of inflation, slowly declining through time.