Submitted by CARPE DIEM

Inflation vs. M1 Growth with a 3-year Lag

The top chart above (click to enlarge) shows the relationship between M1 Money Supply and the effective Fed Funds rate from 1999-2007. Notice that there was a 25% increase in M1 that was required to get the Fed Funds rate to fall from 6.5% in 2000 to 1%. The bottom chart shows that M1 grew between 3.5% and 6.5% in each year from 2001-2004.

The bottom chart allows for a 3-year lag between growth in the money supply and its eventual full effect on the price level and inflation (average annual inflation), and therefore matches M1 growth in 1998 with consumer inflation in 2001, etc.

November 2006-November 2007 inflation was 4.29%, and inflation averaged 2.72% for the year to date, reflecting the strong money growth in 2004 of 5.58% (allowing for a 3-year lag). The good news on the inflation front is that inflation in 2008 will reflect money growth in 2005 (assuming a 3-year lag), which was less than half (2.05%) of money growth in 2004 (5.58%).

Bottom Line: Inflation will not be a problem in the future, and will likely fall in 2008 and 2009 from its level in 2007. The money supply has been flat now for 3 years, suggesting that inflation in the future will be low and stable. The money supply (M1) has actually FALLEN over the last year.

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