Inflation and the supply side: How auto strikes will impact the economy

As inflation has spiked over the last three years, I’ve often quoted the economist Milton Friedman, who argued that:

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.

There are two sides to that. The one that I mostly focus on is the “rapid increase in the quantity of money,” but the other side is just as important: “output.” Put even more simply, inflation arises when the amount of money available to spend on stuff — or “output” — grows more quickly than the amount of stuff there is available to spend it on. It follows that we can have inflation even if the quantity of money doesn’t expand if the amount of stuff available to spend it on declines.

This was part of the story during COVID-19. Not only did the amount of money, as measured by M2, increase by 42% from the fourth quarter of 2019 to the first quarter of 2022, but, thanks to lockdowns and shutdowns, real GDP — stuff, or output — rose by just 2.7% over the same period.

Anything, then, which restricts our ability to produce stuff will, all else being equal, tend to increase inflation. This is how the supply side factors into inflation. The current auto strikes are a case in point. I take no position on the merits of the case of either workers or management, but, to the extent that these strikes reduce the amount of stuff available in the economy to spend money on, they will act as an upward pressure on inflation.

I have been pretty confident in predicting a falling rate of inflation because the rate of growth of the quantity of money has slowed dramatically. That trend stopped in April. If we have more negative supply shocks, the pace of “disinflation” might slow.