When will inflation cool off?

Watch: Money supply
Current read: No cooldown yet

EMAIL  |   PRINT  |   SHARE  |   RSS
 
google my aol my msn my yahoo! netvibes
Paste this link into your favorite RSS desktop reader
See all CNNMoney.com RSS FEEDS (close)
By Janice Revell, Money Magazine senior writer

As you know all too well from the skyrocketing cost of the milk you put in your cereal and the gas you pump into your car, inflation is back. Consumer prices are rising at 4% a year - well above the 2.6% average annual increase of the past decade.

Predicting inflation is one of the most hotly debated areas in economics. Still, there's one signpost worth watching.

What to watch: Follow the money supply. When the Federal Reserve cuts rates, it often does so by buying Treasury bonds from banks, giving them more money to lend and thereby pumping more money into the economy. When the growing supply of greenbacks outstrips demand, each dollar is worth less and buys less.

Presto: inflation. Every major increase in inflation over the past century has been preceded by a spike in the money supply, and a dip in the growth of the money supply has usually led to a drop in the inflation rate.

In the early 1980s, when inflation topped 10%, then-Fed chairman Paul Volcker embarked on an aggressive campaign to slow money supply growth and tame inflation. He succeeded - by 1983, inflation was 3.2% - but at a price. Clamping down on the money supply helped trigger a severe recession - one reason today's Fed is under pressure to keep up money supply growth.

What it's saying now: Going by the money supply, odds are good that inflation will continue rising in coming months. Since last September, the Fed has been on a rate-cutting tear, slashing the federal funds rate by three percentage points in an effort to stave off recession.

As a result, the money supply measure known as M2 has grown by a compound annualized 14% rate over the past two months. To put that in perspective, M2 grew at an average annual rate of 6.1% from 2000 to 2008.

To keep track: You can look up M2 at the Web site of the Federal Reserve Bank of St. Louis.

The wild card: It's not just the Fed that has control over our money. The owners of U.S. dollars can increasingly be found outside the U.S. China holds an estimated $1 trillion, much of it in the form of Treasury bonds. A decision by China to liquidate even a modest portion would drive up the money supply.

Send feedback to Money Magazine

Features
They're hiring!These Fortune 100 employers have at least 350 openings each. What are they looking for in a new hire? More
If the Fortune 500 were a country...It would be the world's second-biggest economy. See how big companies' sales stack up against GDP over the past decade. More
Sponsored By:
10 of the most luxurious airline amenity kits When it comes to in-flight pampering, the amenity kits offered by these 10 airlines are the ultimate in luxury More
7 startups that want to improve your mental health From a text therapy platform to apps that push you reminders to breathe, these self-care startups offer help on a daily basis or in times of need. More
5 radical technologies that will change how you get to work From Uber's flying cars to the Hyperloop, these are some of the neatest transportation concepts in the works today. More


Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.