Since the beginning of this year, the entire world has seen a rise in prices which caused panic and surprise among people; however, the inflation we are observing these last months is not a surprise to those who have seen the monetary and fiscal policy of the governments around the world since the pandemic started. With the excuse of the virus, States have implemented huge spendings which were financed, at least in part, by printing money and other expansionist policies and the results are clear now.
To understand inflation it is fundamental to know that inflation is a monetary phenomenon, in other words, it depends on the money supply and demand in the economy. To many people this statement may be obvious, but it is important to always refresh this concept, especially when some “economists” seem to forget about it.
The goods and services in the economy follow the law of supply and demand, therefore, when the supply is higher than the demand, the price falls. On the other hand, when the demand is higher than the supply, the price increases. The last possible scenario is equilibrium which means that both the demand and supply are the same. What some politicians and economists seem to fail to understand is that the money is subjected to this very same law and the effects are the same to the currency as to any other product in the economy, thus they think there is nothing wrong with creating money out of thin air. There are some other people who understand perfectly well how this works; however, they believe to have the ability to know what is the demand for money in the country and, as consequence, they believe to know how much money should be printed in order to reach the equilibrium point. Nonetheless, these people do not have an idea of what the equilibrium is, therefore, they fail in the same way as the first group of people.
Last year, the governments forced lockdowns on their citizens making many unable to work, earn money in order to provide for their families and destroying many businesses. This obviously crashed the world economy, causing the closing of millions of businesses, making poverty and unemployment rise. As a consequence, the governments came to the conclusion that what could cause a recovery was an injection of money in the economy through the state and central banks. In other words, governments were determined to pursue expansionary fiscal and monetary policies which would be responsible for the rise in prices later on.
The expansionary policies of the government have the objective of increasing the money supply and the currency circulating in the economy, in order to increase activity. The State does that by lowering the interest rate, lowering the reserve requirement, buying bonds and assets, increasing spending and cutting taxes. The central banks are responsible for putting forward the first three and the federal government does the rest. In addition to these measures, bureaucrats around the world could resist their own populist nature and they pushed for programs in which the government would give a check to its citizens and companies. As expected, the states did not have the money to afford these kinds of programs, therefore, the central banks printed money to finance them, increasing the money supply again.
These measures, except for cutting taxes which were not done on a large scale, were harmful for the economy. First, the central banks lowered the interest rate without knowing what was the actual interest rate equilibrium in the market, thus creating an artificial credit expansion. Second, lowering or removing the reserve requirements caused an acceleration of the money creation by banks in the fractional reserve system and also increased credit artificially. Third, buying bonds and increasing spending put money which was not circulating in the economy out in the streets.
The results of all of these policies are obvious to anyone who does not refuse to see reality, the money supply has enormously increased surpassing the demand, therefore, the currencies around the world lost their values and, as much as “experts” say it is transitory, it does not seem to be.
The United States practices almost all the measures mentioned before and it’s a good country to analyze. In March 2020, the federal government signed the Coronavirus Aid, Relief and Economy Security Act (CARES Act) which was a package to give money to companies and individuals, among other things. This package cost 2.3 trillion dollars which is equivalent to 11% of the American GDP. The government also passed the Paycheck Protection Program and Health Care Enhancement Act (483 billions), Coronavirus Preparedness and Response Supplemental Appropriations Act (8.3 billions), Families First Coronavirus Response Act (192 billions) and Consolidated Appropriations Act (868 billions) which together are worth around 6.6% of the GDP. Around one year after the “CARES Act”, the Biden administration passed the American Rescue Plan which cost 1.844 trillion dollars and there are plans to approve the “Build Back Better Plan” which is expected to cost roughly 2 trillion dollars. In monetary policy the United States lowered its interest rate to 0-0.25, purchased securities and Treasuries, eliminated the reserve requirements and printed more than 20% of the money supply in 2020.
The results of these policies are quite evident now, core goods are more than 8% up, core services are almost 4%, energy is 30% up and food is almost 6% up. The overall inflation of the United States is 6.2%, thus reaching a 31-year high.
