Economist Who Correctly Predicted Inflation Predicts More

Economist Who Correctly Predicted Inflation Predicts More
People shop for produce at a store in Rosemead, Calif., on June 28, 2022. (Frederic J. Brown/AFP via Getty Images)
Petr Svab

While the hundreds of economists employed by the Federal Reserve were apparently blindsided by the current wave of inflation, there were economists who got their predictions right. Not only did they get the overall inflation number right, but they also explained why so many others got it wrong.

Based on their calculation, they expect inflation to continue, although somewhat diminished, for perhaps two more years.

“At the end of this year, I don’t see how inflation ... can be less than 7 percent,” Steve Hanke, one of the economists, said during a recent Wealthion interview.

At the end of 2023, he expects inflation to stay elevated at about 6 percent year-over-year.

Hanke, professor of applied economics at Johns Hopkins University, and John Greenwood, chief economist at Invesco in London, predicted in July 2021 that the U.S. Consumer Price Index (CPI), the most popular measure of inflation, would reach at least 6 percent and as much as 9 percent by the end of 2021. The CPI was up by 7 percent in December year-over-year and hit a four-decade high of 8.6 percent in May.

Many economists and politicians, including Fed Chair Jerome Powell and President Joe Biden, have blamed idiosyncratic phenomena such as supply chain disruptions and the Ukraine war for inflation.

These factors are secondary, according to Hanke.

“This is an old game with the White House and the Fed trying to cover their tracks,” he said in a May interview with Larry Kudlow, former economic adviser to President Donald Trump.

It’s true that the COVID-19 pandemic and the related lockdowns have disrupted supply chains. People spent much less on services and much more on tangible goods, which hiked demand for commodities, manufacturing, and shipping. As a result, prices of goods have appreciated much more than those of services.

It’s also true that the Ukraine war and the sanctions imposed on Russia for its invasion have disrupted the oil and grain markets.

But such disruptions should only affect prices in select areas of the economy and only for a limited time. If prices rise across the board, it must be that too much new money has been printed, Hanke argued.

“There is only one cause underlining it all and that’s an excess amount of money that’s been created,” he said.

Hanke and Greenwood have used the analogy of a “monetary bathtub.” The water in the tub is the number of dollars newly printed by the Fed. There are three “drains”: One is the expansion of the economy. If Americans produce more goods and services and the total amount of money stays the same, prices should go down. A certain amount of new dollars thus offsets such a price decrease.

Another drain is the change in the velocity of money, which means how fast money is changing hands in the economy. In recent decades, there has been a growing trend of holding dollars, which decreases the velocity and thus offsets a certain amount of newly printed dollars. Everything else manifests as inflation.

The underlying idea has been encapsulated into the Quantity Theory of Money, articulated by 18th-century economist Henry Thornton based on previous works of John Locke and others and popularized in the mid-20th century by economists Milton Friedman and Anna Schwartz. It states that the quantity of money times its velocity equals the total price level times the number of transactions.

With the money supply (M2) going up by more than 40 percent in 2020 and 2021, “we’re still left with about a 30 percent cumulative increase that’s excess that will eventually come into the system as inflation,” according to Hanke.

Hanke and Greenwood published their analysis in September 2021 in the Journal of Applied Corporate Finance. Yet months later, the Fed and the Biden administration expressed surprise over the persistence of inflation.

If Hanke and Greenwood could figure it out, why wouldn’t the armies of economists at the Fed and the Treasury?

Hanke believes it has to do with ideological blindness.

Nearly all economists at the Fed headquarters in Washington are Democrats, he said, and therefore it’s anathema for them to endorse the views of monetarists such as Friedman, who are generally pro-free market and fiscally conservative.

“The Democrats want to keep Milton and any of his ideas buried, and buried very deep,” Hanke said.

He pointed out that countries that have kept their money printing more in check during the pandemic, such as Japan or Switzerland, are now reaping the benefits of lower overall inflation despite facing similar supply disruption issues as other countries.

“We were right,“ Hanke said. ”Have the reporters picked up on it? No. They’ve canceled this.”

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