Why Is Inflation “Always and Everywhere” A Monetary Phenomenon? Part 1 of 2

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4 MIN READ - As high inflation slowly fades away the Cautious Optimism Correspondent for Economic Affairs wants to address Milton Friedman’s famous witticism in a little more detail—before inflation leaves the news headlines.

Milton Friedman said it.

CO preaches it.

The Cautious Optimism Economics Correspondent agrees with it.

“Inflation is Always and Everywhere a Monetary Phenomenon”

But why? After all there are plenty of critics—such as Elizabeth Warren, AOC, and Modern Monetary Theory scholars—who disagree that inflation is always caused by expansion of the money supply. They think there are other factors that cause the general price level to rise consistently and relentlessly.

So perhaps it would help to explain why inflation is always caused by money, and more importantly why some of the most popular alternative explanations are really fallacies.

ONCE AGAIN: THE EQUATION OF EXCHANGE

First of all, let’s establish that even though low inflation is also caused by money, for the purposes of this discussion we’ll use examples where inflation has been high enough for the public to feel real pain. That would include the 2021-2023 period where official annual CPI peaked at 9% in June of 2022, the 1970’s decade where inflation routinely measured for six years from the high single digits to even 15%, or much worse hyperinflations in places like Zimbabwe and Venezuela.

So going back to the all-important equation of exchange, which is indispensable for understanding inflation:

mv = py, or better yet

p = mv/y

Changes in “p” (prices) are driven by three factors:

-Changes in “m” (the money supply)

-Changes in “y” (real output), and

-Changes in “v” (monetary velocity)

Yes, there are people like AOC and the media who argue there are even more reasons for rising prices: “corporate greed,” “cost-push inflation” where the price of one major input like oil goes up and causes a ripple effect, or “supply chain disruptions.”

The Economics Correspondent isn’t going to focus on those in part because he’s already addressed the first two. You can read more about “corporate greed” at:

https://www.cautiouseconomics.com/2024/09/inflation-currencies42a.html

…and “cost push” at:

https://www.cautiouseconomics.com/2025/01/inflation-currencies45.html

And "supply chain disruptions" are not only already reflected in a decline in output ("y"), thereby being superfluous, but the reality is Covid lockdown-related supply chain disruptions were largely ironed out by 2022, yet the inflation rate did the opposite of what it was supposed to. Instead of falling, the inflation rate went straight up.

OBJECTIONS TO "MONEY" (YES, REALLY)

But back to the equation of exchange and the three elements that actually drive price changes. We’re going to address objections to the money part here and talk about output and velocity in the second installment.

The “m” (money supply) is a pretty easy concept for people to grasp. The public sees prices rising quickly and they notice the central bank’s figurative printing press is also running hot.

And if you look at any period in American history—or any other country’s history for that matter—where price inflation takes off, you’ll find a sizable increase in the money supply at the same time, or in some cases slightly beforehand.

(More on the “slightly beforehand” part when we get to explaining velocity in Part 2)

Here’s just one recent corroborating example: When inflation took off in late 2021 and 2022, the money supply measured by M2 also increased by 13% from January 2021 to April 2022, much faster than the 4% expansion of real output.

What a shock. Prices started rising rapidly.

And for those old enough to remember it, there’s also the famous “stagflation era” of the 1970’s and early 1980’s. From 1970 to 1982 prices rose by 157% meaning the dollar's purchasing power fell to 39 cents in twelve years, which was a killer for retirees and savers.

Unsurprisingly M2 expanded sharply over the same period: by 238%.

But believe it or not, there are actually some people who argue that sometimes inflation simply isn’t caused by an expansion in the money supply. And we’re not just talking about geniuses like AOC and Bernie Sanders.

The main objection the Correspondent has heard over “money” in particular comes from the likes of, for example, investment manager and former Dallas Fed economist Lacy Hunt who is far smarter than AOC.

Hunt compares a long-term chart of M2 against inflation and points out that yes, there are cases where inflation was accompanied by monetary growth, but there were also many cases where M2 rose very rapidly but inflation didn’t take off at all.

The examples are too many to provide here, but a good one is the mid 1980’s where during both 1983 and 1986 M2 rose quite rapidly yet inflation was subdued (see URL chart).

https://fred.stlouisfed.org/graph/fredgraph.png?g=1ErDy

While Hunt’s a very good economist and his observations aren’t incorrect, the problem in this case is his assertion disproves nothing that Milton Friedman said.

To go back to his famous quote, Friedman was very careful and deliberate with his use of words. He never said:

”Monetary phenomena always and everywhere cause inflation.”

Friedman proclaimed the reverse:

”Inflation is always and everywhere a monetary phenomenon.”

Again, Friedman was very precise with his wording. And Hunt is basically destroying a completely different argument, one that cites a reverse cause and effect.

Yes, sometimes when the central bank creates new money inflation remains subdued, usually because of lower monetary velocity—the 2020 lockdowns being a good example. But Friedman never said that every single time you see the money supply grow you’ll also see high inflation. He said that everywhere you see inflation you’ll also see money growing, which is a very different thing.

So kudos to Hunt for noticing sometimes money goes up and inflation doesn’t, but that doesn’t have anything to do with Friedman’s famous dictum.

In the concluding column we’ll address those who object to Friedman’s inflation thesis based on other (alleged) causes: output and velocity.