The ghost of Milton Friedman is haunting President Biden

In a puzzling statement when he was running for the presidency, now President Joe Biden said “Milton Friedman isn’t running the show anymore.” Quite what he meant by that is anyone’s guess, but as Americans sour on his presidency in response to rising inflation (among other things), Friedman is having the last laugh.

One of Friedman’s most popular quotes is:

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.

Let’s unpack this a bit.

If we follow Friedman’s method and divide the M2 money supply by real GDP to get the quantity of money per unit of output, we see Figure 1. This shows a steady increase in this figure over time and then a very sudden jump from January 2020. If we accept that changes in the CPI are largely driven by changes in this figure, current inflation should not surprise us.

Figure 1: Quantity of money per unit of output in the United States

What is causing this jump? Changes in the ratio of M2 to real GDP can be driven by changes in either — or both — of M2 or real GDP. Figure 2 shows changes in both M2 and real GDP since the end of 2019. We see that while real GDP — the amount of stuff there is to buy — grew by just 1.9 percent between Q4:2019 and Q4:2021, the amount of M2 — the money there is to buy it — increased by 40.3 percent.

Figure 2: Changes in M2 and real GDP, Q4:2019 = 100

Friedman’s view used to be somewhat crudely summarized as saying that inflation comes from “too much money chasing too few goods” and that neatly captures the situation here. The inflation that is damaging the Biden administration so badly, to say nothing of the finances of ordinary Americans, is playing out just like Friedman would have predicted. When it comes to monetary economics, Friedman certainly is still running the show.