Why Is Inflation “Always and Everywhere” A Monetary Phenomenon? Part 2 of 2

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6 MIN READ - The Cautious Optimism Correspondent for Economic Affairs and Other Egghead Stuff concludes his commentary explaining why inflation is always and everywhere a monetary phenomenon.

In Part 1 we reviewed Milton Friedman’s famous witticism that “Inflation is always and everywhere a monetary phenomenon.”

We also looked at the three factors that drive changes in the price level: money, economic output, and monetary velocity, expressed as:

p = mv/y

And we debunked one argument that claims to prove empirically that inflation is not always caused by growth in the money supply.

Part 1 can be reviewed at:

https://www.cautiouseconomics.com/2025/05/inflation-currencies46.html

In this second and final installment we’ll address critics of Friedman—most notably Modern Monetary Theory (MMT) devotees—who claim inflation, and even hyperinflation, are caused instead by changes in output. We’ll also discuss the final variable of velocity.

OUTPUT

The next variable in the equation of exchange is “y” or real goods and services. 

This is one that’s not too hard for the public to understand either. Anyone who’s ever said “Inflation is too much money chasing too few goods” has a good grasp of how “m” (money) and “y” (output) affect changes in prices.

Some Friedman critics, particularly MMT theorists, argue that inflation is sometimes caused not by an increase in the money supply, but instead a big drop in output.

The most popular MMT example the Correspondent has heard is Venezuela where they argue “Venezuela’s hyperinflation wasn’t caused by printing too much money. It was their socialist policies that caused a huge drop in economic production. Too few goods led to higher prices.”

Now keep in mind that at its peak Venezuela’s inflation rate surpassed 100,000%, with some outside economists estimating the actual inflation rate was closer to 1,000,000%.

100,000% inflation means prices rise about one thousand-fold per year. This should clue some people in right away that the MMT “falling output” explanation is already on thin ice.

Because simple math informs us that if a thousandfold increase in prices is the result of fewer goods and services, Venezuela’s real economic output would have to have contracted to 1/1,000 (one-one thousandth) the level of the prior year; i.e. down 99.9%.

Venezuela’s economy undoubtedly contracted in the late 2010’s, but it did not shrink by 99.9% in one year. Furthermore another year of 100,000% inflation means the economy shrank by another 99.9% for a grand two-year total of 99.9999%.

Venezuela’s workforce was estimated at 13.2 million people in 2017. For output to have fallen by 99.9999% in two years the entire national economy would have to have withered down to just 13 Venezuelans working, down from 13.2 million.

With that kind of decline literally everyone in the country would have starved to death with the urban geography of the entire country totally depopulated—all corpses being eaten by stray animals except for 13 people: likely President Nicolas Maduro and his cabinet.

Scratch that. Those thirteen socialists couldn’t produce enough of anything to maintain even 0.0001% of the country’s original output so let’s call it 13 factory workers instead.

Obviously falling output, or “y,” did not cause Venezuela’s hyperinflation.

But money did.

In 2018 Venezuela’s money supply is estimated to have increased by 82,500%, although output fell as well, by a stunning 19% (not 99.9%). 

If we still want to blame output in a scenario where money stays constant, then a 19% decline in real GDP would have led to prices rising by just 1 / 0.81 = +23.4%. Again, 23.4% is not 100,000%, not even close.

The same MMT fallacy can be discredited simply by looking at the USA during the inflation of the Biden presidency.

From January 2021 to January 2025 official CPI increased by 21.5%. If this is to be explained by shrinking output then the real economy would have to have contracted by a catastrophic 17.7%.

But real GDP actually grew by 11.8%.

In fact, trying to blame any period of serious U.S. inflation on lower output is kind of ridiculous when simply looking at math again.

If one looks at the Great Recession of 2008-09, real output peak to trough fell by about 4% in a little over a year. That period, when so many people were losing their jobs, losing their homes, and the entire country felt like it was mired in misery and hopelessness, reflected a 4% decline in output.

So if we repeat the same scale of recession again and money remains constant, the resulting annualized inflation would be just 1 / 0.96 = +4.2%.

Official inflation in 2022 alone was up 6.3%.

And what about the inflation of the 1970’s? When annual inflation exceeded 8% in six out of ten years? Obviously the USA was not experiencing a Great Recession level contraction six out of ten years. And remember, even a Great Recession level contraction is only enough to produce inflation of 4.2%.

Simple math once again tells us if the MMT “output” theory is correct then 4% inflation would require Great Recession level contractions of economic output. 9% inflation would require Great Depression levels of contraction. 

4% and 9% inflation has happened many times in the Fed era and never have they coincided with Great Recession and Great Depression slumps.

And 20% inflation would require catastrophic slumps in output with widespread hunger plaguing the country. Mid-double inflation levels would mean mass famines like those seen during Stalin’s Holodomor, Mao’s Great Leap Forward, or the 1990’s North Korean famine. Yet mid double-digit inflation is an everyday occurrence in many developing countries today where mass famines aren't taking place (Sri Lanka: 48%, Turkey: 73%, Haiti: 29.7%).

Bottom line: Inflation levels like those in 2022, the 1970’s, and especially hyperinflations, simply aren’t caused by falling output (y).

The only way falling output could ever cause high double-digit or even low triple-digit level inflation would be if half an entire nation’s productive capacity was wiped out by war—at which point the losing government would be printing money like crazy anyway—or some cataclysmic natural disaster.

But not in the USA. If we go back to the stagflation era of the 1970’s the money supply measured by M2 rose by 232% from 1970 to 1982.

Shocking. Once again, inflation was a monetary phenomenon.

VELOCITY

The last variable is monetary velocity, or how quickly money changes hands via spending or borrowing.

The Economics Correspondent hasn’t heard too many people try to discredit Friedman using velocity, but it could be tempting. Because rising velocity *does* legitimately cause inflation.

What was that? Something other than money really does cause inflation?

Not, exactly. Keep reading.

When consumers and businesses expect high inflation to continue into the future, they tend to spend their money faster because they fear it will lose value if they hold it. 

The best example that springs to mind is the Weimar Republic hyperinflation where factory workers, once paid, immediately ran to the plant entrance gates to hand the banknotes to their wives and instructed them to spend all the money as fast as they could on anything they could find (before the notes lost value the next day).

The entrenchment of higher monetary velocity is called “inflation expectations” and it has frustrated the Fed’s efforts to rein in the recent inflation of its own creation. Even though the Fed was able to stop money growth in its tracks back in 2022—M2 is still 2.1% lower today than it was in April of 2022—prices have continued to rise even in the face of growing real GDP because consumers have been spending their money faster and faster.

So does this problem of higher velocity disprove Friedman’s assertion that inflation is “always and everywhere” a monetary phenomenon?

Nope, for the simple reason that you have to look at what caused the inflation that led to higher velocity in the first place.

Every example of observed velocity-driven inflation has been preceded by an actual monetary inflation first. Once that monetary inflation settles in, consumers and businesses have responded by changing their expectations, and then changing their behavior by spending money faster (i.e. rising monetary velocity).

This vicious cycle of more money followed by higher velocity leading to even faster inflation has been especially acute in history’s hyperinflations such as the aforementioned Weimar Germany example along with Venezuela, Zimbabwe, late 1940’s Nationalist China, post-WWII Hungary and Yugoslavia, the post-breakup Soviet Republics, etc. 

The list is quite long, and we even witnessed it during the 1970’s and early 1980’s. The Paul Volcker Fed jacked up interest rates and drastically slowed the rate of money growth, yet prices kept rising quickly anyway. Inflation expectations had become engrained in the public's thinking leading to higher velocity.

Volcker was forced to push rates up even higher—to a punishing 21%—and leave them there for a while to finally get Americans’ spending habits to revert back to pre-inflationary behavior. In the process of slowing both money growth and monetary velocity Volcker was forced to produce the sharp 1982-83 recession where unemployment reached 11%.

So if Friedman wanted to be more technically accurate in addressing velocity he might have instead said:

“Inflation is always and everywhere a monetary phenomenon, and where it’s driven by rising velocity the velocity itself was spurred by a monetary phenomenon too.”

But that would be too much of a mouthful. Not very catchy and quite forgettable.

The original quote suffices quite well:

”Inflation is always and everywhere a monetary phenomenon.” 

And so it remains.