Money supply? Or interest rates? Which impacts inflation more?

Consumer prices respond to supply and demand of goods and services by consumers. Although the WSJ article below focuses on M2, the money that is spent by consumers is actually M1.

M2 is the U.S. Federal Reserve’s estimate of the total money supply including all of the cash people have on hand plus all of the money deposited in checking accounts, savings accounts, and other short-term saving vehicles such as certificates of deposit (CDs). Retirement account balances and time deposits above $100,000 are omitted from M2.

The Federal Reserve tracks a separate money supply number, called M1, that includes currency that is in people’s pockets or in their checking accounts and savings accounts. The money that is deposited in time deposits and money market funds is not counted in M1. For the Fed’s purposes, this is “near money.” That is, the funds cannot be used as a medium of exchange and they are not instantly convertible to cash.

The article also fails to mention consumer borrowing, the source of most people’s money for large-ticket purchases such as homes, cars, education and medical expenses.

Monetarism Is Back. It May Not Last.

Some on Wall Street predict bad times because of an unprecedented drop in the money supply

[James Mackintosh

By James Mackintosh, The Wall Street Journal, Updated Oct. 6, 2023

The supply of money—the core variable at the heart of monetarism—is shrinking. This suggests the Federal Reserve, Bank of England and European Central Bank have gone too far and bad times are ahead.

The Fed focused on controlling the money supply under Chairman Paul Volcker from 1979, but slowly moved back to concentrating on the price of money, the interest rate.

… A paper by the Bank for International Settlements this year concluded that there’s no link between the quantity of money and inflation when inflation is low. But in a high-inflation regime, [money supply is a near-perfect indicator](Does money growth help explain the recent inflation surge?). Looking at the money supply would have helped economic predictions after the pandemic, not only for individual countries but also when comparing inflation between countries.

“The countries that printed the money had the inflation…

The leap in inflation wasn’t because of monetary policy alone, either; it took off in large part because money was handed out by the government as stimulus. In other words, inflation was due to fiscal, not monetary, policy.…" [end quote]

It’s important to note that Federal Reserve policy (interest rate changes) impacts banks directly. The banks decide on consumer loans. If banks don’t lend low-interest money to consumers but invest in the asset markets, as happened after the 2008 financial crisis, asset markets will rise but not consumer inflation. However, government spending goes directly into consumer hands. This impacts consumer inflation.

The Federal Reserve, which controls monetary policy, often works at cross-purposes to Congress, which controls fiscal policy. During the Covid pandemic, both worked together to strongly boost both monetary and fiscal stimulus. This led to inflation in 2022. The Fed has since tightened policy by raising the fed funds rate. Emergency government spending has been phased out but large deficits are still providing fiscal stimulus.

M1, money that can be immediately spent by consumers, is still very high (compared with historic levels) even though some of the Covid bonanza has been spent. M1 has dropped slightly since Jan 2022. Household income is at a record high and still rising. Personal savings dropped as the stimulus money was spent but is now rebounding due to the strong job market. Personal Consumption Expenditures and Consumer debt are both at a record high and still rising.

“Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output,” Nobel Prize winner Milton Friedman wrote in 1970. Quotes of this sentence often omit the critical second part. If supply rises as fast as demand there will be no price inflation, even if the money supply rises.

As Covid-driven supply chain problems gradually resolve, supply of some goods will meet demand and prices won’t rise. However, most of the U.S. economy is services, not goods. With a constrained labor force and spreading strike activity, price inflation in many services could drive overall inflation.

Will a slightly falling money supply impact this strongly, given growth in income, borrowing and expenditures?

I don’t think so. I think that inflation will last longer than people expect. A recession that leads to layoffs and lower income would stop inflation. Not before.



Friedman came nowhere near inventing that insight. He was parroting it. It was long known before him.

Friedman used the concept for his disastrous ideas. Samuelson proved every single policy Friedman came up with as inept, backward, and destructive of the US economy.

Samuelson used metrics to form his proofs. Friedman never measured a single thing to prove anything. Friedman never had proof anything he said worked. It did not.


And yet inflation has declined from a high of almost 10% to barely 2.2% without the slightest blip in the unemployment rate or even the vaguest notion of a recession.

Yes, what’s truly soaring is … disinflation denial.

Friedman was so obviously wrong here. Pretend, for a moment, that money supply stays exactly the same. Now also pretend that there’s a, oh I don’t know, pandemic that interrupts supply chains making it hard to get products to market. What will happen? Obviously shortages and the bidding up of remaining stocks, whether it’s bathroom tissue, new cars (used car prices trickle up, too), housing, or any of the other things we so take for granted in our daily lives. Yes, I realize this is a purely theoretical exercise and nothing like this could ever happen, but (pretending again) if it did, you might find that inflation would fall back to a more normal level, but prices would remain at a new elevated level because price inputs to production would likewise have been affected. Temporarily. But the price levels would remain higher because of short term things like profiteering leading to gigantic corporate profits and stock buybacks, and on the other side workers clamoring for raises to keep up with what would have been temporary issues.

If, by chance, during this entirely theoretical pandemic you also increased the money supply, then you would surely have inflation, it’s true, but it might not be the driving force the inflation hawks have assured us for 40 years+ that it must be.

It already has. But it is a temporary phenomenon in this case and any dispassionate look at the trends would convince any but the truest believers that the peak is already past.


That’s probably because employment is still recovering from COVID. Recently, we’ve nearly reached the pre-COVID level, but just nearly, haven’t quite reached it yet. Unfortunately it seems to have started leveling off.

It’s also wrong for a different reason. In theory, it could only be correct in a closed system. But in a “globalized” system, it doesn’t even have a chance of being right, because there are more than one monetary authority, and the various ones may all be doing different (or the same) things at any given time. And there are so many “off the books” things that it hard to even measure properly anymore.


On a related tangent, our working age population has decreased by roughly 7 million people. It has not been this low since 2010 and as a percentage of the total, not this low since 1977.

What Is The Working Age Population In The U.S.? [2023]: Statistics On Prime Working Age Population In America - Zippia.

We may not get back to the pre-Covid levels of employment again in our lifetimes.


These numbers are percentage of working age population, not percentage of all population. So if working age population went down by 7 million, that means that the denominator went down by 7 million.

Why wouldn’t/why shouldn’t we reach, or even exceed, that percentage? Why is only 60% of working age people actually working acceptable? It should be much higher than that!

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I completely agree. We have throngs of people who are not seeking work today that were reliably donning the hard hat and grabbing the lunch box before. Part of that is aging (3 years on from Covid), part of that is a structural change in attitude (retirement, 'lying down movement, gig work from home, etc.).

Our low unemployment number relies on hidden “no longer seeking” portions of our working age population.

This is evidentially supported by every factory in my horizon. We are paying structurally higher wages at every post and suffering turn over and absenteeism in numbers 40-360% higher than before.


If you think I was posting in opposition to your post, you are incorrect. I was adding additional insight. I am aware of how the percentage is calculated.

For a number of potential factors. First off, the percentage has never been very high. If you view the link above, it is consistently between 61and 66-67%. We now have a participation rate similar to what we had in the late 60s and early 70s.

The declining health of our population is likely a factor. Note our participation rate was trending downward before Covid. We had our highest rate in 2006, just before the financial crisis, and it went down every single year since (until 2022). That suggests something else is going on more significant than just Covid.

There are probably other factors at play as well but I see no reason to assume we will necessarily ever get back to our all-time high of 67%.


You’re probably looking at a different chart than I am. This chart (the one I linked to) shows a rising trend from 2010 until COVID.

I’m not sure a comparison to the 60s/70s is appropriate because that was before women entered the workforce en masse. Having a 55% participation rate in the 60s was absolutely TERRIFIC considering that a very large percentage of half the population didn’t even consider working at a wage-paying job!


I am. My data is directly from - and is different that yours. Pretty significant disconnect.

Note the dates are truncated in the image but if you go to the source, you will see that the chart reflects September 2003 through September 2023 - with the high point in 2006 - and a consistent downward trend from there.

Another chart worth viewing is this:

Again, truncated but what is important to note is that our numbers today are very near the numbers of 2006 - which means that we have lower participation than 2006 while having about the same number of people not in the workforce - meaning that there is a fairly low ceiling (or very high floor?!?) on how much lower than number can reasonably go.


With industry coming back people will be incentivized to enter the labor market.

60.4% is a very deep low. The US usually operates around 66% over the decades.

The factors being cited are more minor. The issue is pay. The part-timers may not be counted. But I am not sure of that. We have had high levels of part-time workers.

It looks like MarkR is looking at the “Employment rate”, which is the number of people working relative to the working age population. A lot of working age people were discouraged from work by the Great Recession of 2008 and those numbers are only just returning to pre-recession levels when the pandemic hit.

Hawkwin is looking at the “Labor participation rate”, which is the number of workers relative to the total population. That metric has been declining because the population is aging faster than immigration. That’s the inverted population pyramid at work.

Apple, say hello to orange.


What is excluded from labor force participation rate?

Unemployment Rate

People who have not looked for work in the past four weeks are not included in this measure. It is important to keep in mind that the rate measures the percent of unemployed job seekers in the labor force—the sum of employed and unemployed persons—and not the entire population.

How to calculate the employment rate?

Employment Rate Formula

To calculate an employment rate, divide the number of people employed by the number of people in the labor force.Jul 27, 2023


You are trying to discuss the workforce involvement.

How many Americans are out of the workforce?

U.S. inactive labor force seasonally unadjusted 2021-2023

In August 2023, the inactive labor force amounted to about 99.16 million people in the United States. Labor force measures are based on the civilian non-institutional population 16 years old and over.


The Alphas are a declining population but do not matter to this as they are very young.

The Z’s are a larger generation. The Millennials are larger than the Boomers. The population of workers is not aging by much if at all.

I have a friend born in 1935 the lowest birth rate ever in the US that year. The Great Depression did not last. Because there were fewer people for the jobs he could do anything he wished in the labor force. The aftermath was the baby boom.