Inflation Update

1. Thanks to Scott Grannis for this thoughtful response on his Calafia Beach Pundit blog to this CD post about annual M2 growth falling recently to 4.5%, the lowest growth since late 2005, and what that means for future inflation. Scott makes the supply-side case for rising inflation:

One of the key insights of supply-side economics is that free markets are excellent sources of real-time indicators that can be used to tell, for example, whether monetary policy is inflationary or not. It's rather simple: if there are too many dollars in the system, then we would expect to see some or preferably all of the following: a) the value of the dollar falling relative to other currencies, b) gold prices rising, c) commodity prices rising, d) the yield curve steep or steepening, e) credit spreads tightening (since easy money is great for debtors and should reduce default risk), f) inflation expectations as embodied in TIPS prices rising, and g) currency growth falling (currency becomes a hot potato when inflation rises, so the demand for currency should fall). All of these are symptomatic of a situation in which the supply of money exceeds the market's demand for money.

Since we have been seeing most or all of these rising inflation symptoms for the past year or so, that's why most supply-siders have been predicting rising inflation even though M2 growth has slowed down rather remarkably (M2 growth is essentially zero over the past six months). Caveat: this is a highly contentious issue about which reasonable men can and do disagree.

2. Speaking of reasonable men/economists disagreeing, the consensus forecast from the most recent (Dec. 4-7) WSJ survey of 52 professional economists seems to disagree that rising inflation will be a problem in 2010 (see chart below). The consensus forecast is for CPI inflation to be about 2% through next year, falling to 1.8% by the end of 2010.

If that is the case, annual inflation in 2010 would be the lowest since the 2.04% inflation in 2003 (December 2002 to December 2003), except for 2008, which experienced almost no inflation (-0.08%). Even Brian Wesbury and Bob Stein are predicting inflation of "only" 3.5% by December 2010, just slightly above the 2.8% average since 1990.