Money in circulation and inflation in the US

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Money in circulation and inflation in the US

INTRODUCTION

Money is an important exchange medium, entity of account as well as a stock of value. The various functions that money serves are directly related to its pragmatic value. In any given economy, it is impossible to determine the accurate amount of money in circulation. There exists numerous measures that are categorized along scales between constricted and expansive monetary summative. Money in circulation for dollarized economies often gets unstable, making it hard to properly control inflation (Nienke and Ohnsorge 67). Inflation creates one of the most severe economic challenges of our current times. It implies quite a number of social prejudices that many citizens are grieved by.  Inflation results in economic instability leading to a decrease in efficiency and retardation in economic growth of a given economy with time. Gottfried (43) defines inflation as an expansion in the monetary circulation instead of a rise in the price level; more precisely as an increase in the product of the quantity of money and the velocity of circulation of money.[1]

In any economy, the amount of money in circulation has a direct impact on the inflation in the economy. The situation of Zimbabwe, an African nation, has prompted a lot of research work by many economists. Key among them is Krugman (72) who states that, by the summer of 2008, the African nation of Zimbabwe had achieved an enviable distinction: in June 2008, it had the world’s highest inflation rate of 11 % a year. [The government kept introducing even larger denominations of its currency. Suffice it to say, the Zimbabwean currency value depreciated so that its value was so miniature that bank cash withdrawals were made using suit cases.

Even though Zimbabwe’s case seems the most shocking of all times, the situation was mild and cannot stand comparison to the chronicle’s most popular example of extreme inflation that occurred in Germany.  In the light of what Krugman (96) has documented on this topic, it is evident that money issue had grave impact on the country’s economy between the years 1922-1923. This inflation has been described as a hyperinflation and towards its end, commodity prices were increasing at the rate of 16% each day. This hyperinflation made Germans reluctant to use the currency notes as its worth was depreciating hourly.

Bruce D Smith (84) evaluates the money supply and inflation in colonial Massachusetts. Consequently, for this research paper, it is paramount to appreciate the contribution of the level of money supply to inflation. In this research on colonial Massachusetts, the author clearly defines the amount of money in circulation as a key determinant of the country’s inflation rate. The situation in this country saw prices increasing by 618% and 800% in 1970. The government minted more currency and this led to depreciation in currency value resulting in increased rate of inflation characterized by high commodity prices. The country’s situation has been best described by use of the quantity theory of money which proposes that growth rate of money in circulation is roughly equal to the rate of inflation. This research will be conducted to investigate the impact of money issue on inflation in light of independent and dependent variables in the US. The main objective of this study is to determine the consequences of monetary policies and the contribution of these consequences to inflation and the reasons behind the loss of purchasing power of per unit money in the US economy. This paper includes some data in the SAS system that will be analyzed in the regard of this topic in order to reach sound conclusions. In the analytical section of this paper, money circulation is represented by X and is the independent variable while inflation is the dependent variable Y. This paper seeks to explore the relationship between X and Y and to explain the dependence of Y on X. Finally, the paper will give an extensive discussion on the phenomenon; the same unit of money purchasing fewer commodities in the face of inflation.

 

 

ANALYTICAL SECTION

            For the purpose of accurate analysis of the data for this specific research, M2 was used. M2 implies that the Federal Reserve Notes, the US Notes and Coins (whether is held inside or outside of the private banking system as reserves) in addition to the demand deposits amount, checkable deposits, money market accounts, travelers checks, savings accounts, retail money market mutual funds, and small denomination time deposits (Taylor 45).

            Money supply and inflation are two economic variables that are dependent on each other in one way or another. Money supply is however the independent factor since it is entirely a decision made by the central financial organ in a country. Inflation in this case is the most dependent factor. It is possible, economically, to have an increase in the amount of money supply in a country without necessarily leading to an increase in the inflation levels. Inflation is however dependent on it in the following way: with an increase in the amount of money supplied for economic usage within a country, there is a resultant increase in the money at the citizen’s disposal. Commodity prices in the same line rise from the various sectors of the economy both for the goods and services (Steven 67).

            Indeed, economists have a universal concurrence amongst themselves that there exists a connecting relationship between the prices of goods and services and the demand and supply of money. When considered in economic provisions, this is very true but there exists no general conformity concerning the accurate system and relationship linking price inflation and money supply.

 

 

 

STATISTICAL MODEL/REGRESSION EQUATION

 

 

Graph showing money supply for the past 30 years.

There has been a gradual but consistent increase in the amount of money released by the commercial banks for circulation in the U.S. over the years.

 

 

 

 

 

Graph indicating the levels of inflation rates in the United States between 1982 and 2012

The variables used for this research include inflation and money supply. 

The relationship between real GDP and inflation

This is given by the equation obtained through regression analysis:

                           y= 5.934955X-0.219151

The negative gradient implies a negative relationship between the real GDP and level of inflation.

 

            The relationship between the income level and the inflation

This is given by the equation obtained through regression analysis:

                              Y=13.46X+0.00021

The negative gradient implies a negative relationship between the income levels and level of inflation

 

DATA SOURCES

The data used in this research have been collected from various verified financial records based in the United States dating back to over 30 years of age. Among the data that was collected include inflation rates date both on quarterly basis and annual basis for the past 30 years from 1982 up until 2012. Data on the United States real Gross Domestic Product and the mean wages for the citizens were also used.

The rates of inflation used for the research had been pre-calculated using the Current Consumer Price Index. The used data had been published with monthly records by the Bureau of Labor Statistics. According to the information retrieved from the source site, the data recorded had been last updated in May 2013 and covered up until the month of April 2013 (Krugman 56).

 

 

EMPIRICAL RESULTS AND DISCUSSION

For this analysis, the yearly data was used. This is because the data collected for the past 30 years are very large and complex to deal with. The use of quarterly data would have implied 120 different classes of data used for the project. There are also other data that do not have records on quarterly basis and, therefore, in this case forming comparison basis would be difficult. The data collected over the past 30 years were sufficient enough to make comparisons, make interpretations and draw conclusions which are sound enough.

            From the results from the graphs, it is very evident that inflation to a certain limit depends on the money supply and circulation in a country. For this research data, the United States was used to develop the relationship between money supply and inflation rates in a country and in the determination of whether or not the inflation faced in a country is dependent on the money supply. The apparent relationship and connection for the above variables is that for each and every additional supply of dollar money, there is a proportional and comparative increase in commodity prices. It is however notable that when there is an economic growth in a country or an increase in a countries productivity, then the relationship changes. In the charts on inflation and money supply, someone would take it like the numbers of the two decades are larger than that of the annual rate of inflation.

A deduction from the charts indicates that there has been a cumulative total inflation for the years 1990 until the end of 2000 of 33.4% which is a representative data for 10 years. From 1982 to 1992, a cumulative total inflation of 44.3% was recorded. The value is however lower between 2002 and 2012 where the cumulative inflation sums up to 26.0%. These figures are quite less and minimal compared to the inflation rates in the 1970’s where the cumulative inflation was at 102.9% over the entire decade. The numbers in two of the decades, from early 1980s coming up to early 2000s, there is a noted huge rate of inflation in the country. Values rose from 2% to over 5%. Though there has been a fluctuation as a result of rising and falling rates of inflation, it is still worth noting that a yearly incremental rate of inflation cumulatively results to a huge inflation rate using an earlier base year. To a level, it is evident that though there has been an increasing amount of money in circulation through the treasury adjustments to cater for developments and as a result of improving production rates within the country. Inflation patterns are also dependent on quarterly financial periods.

Deeply analyzing the different graphs derived from the data collected on the national statistical records on inflation and money supply indicate differently. Over the years dating to 30 years back indicate that as much as there has been an increasing rate in the supply of money to the circulation channels, there has been a noted decrease or reduction in the levels of inflation within the country.  

 

 

 

CONCLUSION

            This research was based on the relationship between inflation rates and the money supply in the country. Though other constants such as economic growth of the country and the Current Consumer Price Index and income rates were introduced in the research, it was only in a bid to understand the other economical underlying factors that may as well be affecting the influence. The other factors are, therefore, not used to back the economic growth in the research. The prices of commodities are found to decrease when there is economic growth due to increased economical productivity. When there is an increased money supply while at the same time there is an economic growth, then the result is unwavering prices; money supply growth above economic growth will lead to increases in prices.

            Price inflation comes as a result of money supply increase in excess of a countries economic growth. When the money supply released by the central commercial institution of a government is at or below the economic growth, then there is no resultant inflation. But when there is a release of huge amounts of money beyond the economic growth then there is a resultant inflation to that effect. This may well be in the countenance of a developing economy or a waning economy. There is indeed a relative relationship flanked by money supply growth and economic growth. Inflation therefore depends on the money supply in a country. The actual explanation for the rapid economic inflation for the past 30 years is similar to the explanation for economical inflations in the early and late 1970’s. There has been unregulated release of money by the Central Banks even when the economy was poorly performing and declining. As a result, there has been an excess release of money into the economy leading to economical inflation. Therefore, even when the money supply increment has not been massive, it has been in excess relative to the principal financial system and has led to price inflation.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Works Cited

Bruce,  Smith. Money and inflation in colonial Massachusetts federal bank of   Minneapolis. Quarterly review, 1984.

Krugman, Swann. GDP and the Economy: Advance Estimates for the Third Quarter of 2007, 2007, pp. 45-68.

Gottfried, Harberl1er. Inflation its causes and cures. Chicago: American enterprise association Washington, 2005.

 Nienke, Oomes and Franziska Ohnsorge, 2005. Money demand and inflation in dollarized economies: the case of Russia. Retrieved from      <www.worthpublishers.com/krugmanwells>

Steven, Andrews. Adjusting for Inflation: Price Deflators and Real Estimates. Cambridge: Harvard University Press, 2007. Print.

Taylor, Lawn. Reconstructing Macroeconomics. New York: Springer, 2007. Print.

 

 

 

 

 

 

 

 

 

 

APPENDICES

Year

Avg

Jan

Feb

Mar

Apr

May

June

July

Aug

Sept

Oct

Nov

Dec

2013

1.50%

1.59%

1.98%

1.47%

1.06%

 

 

 

 

 

 

 

 

2012

2.07%

2.93%

2.87%

2.65%

2.30%

1.70%

1.66%

1.41%

1.69%

1.99%

2.16%

1.76%

1.74%

2011

3.16%

1.63%

2.11%

2.68%

3.16%

3.57%

3.56%

3.63%

3.77%

3.87%

3.53%

3.39%

2.96%

2010

1.64%

2.63%

2.14%

2.31%

2.24%

2.02%

1.05%

1.24%

1.15%

1.14%

1.17%

1.14%

1.50%

2009

-0.34%

0.03%

0.24%

-0.38%

-0.74%

-1.28%

-1.43%

-2.10%

-1.48%

-1.29%

-0.18%

1.84%

2.72%

2008

3.85%

4.28%

4.03%

3.98%

3.94%

4.18%

5.02%

5.60%

5.37%

4.94%

3.66%

1.07%

0.09%

2007

2.85%

2.08%

2.42%

2.78%

2.57%

2.69%

2.69%

2.36%

1.97%

2.76%

3.54%

4.31%

4.08%

2006

3.24%

3.99%

3.60%

3.36%

3.55%

4.17%

4.32%

4.15%

3.82%

2.06%

1.31%

1.97%

2.54%

2005

3.39%

2.97%

3.01%

3.15%

3.51%

2.80%

2.53%

3.17%

3.64%

4.69%

4.35%

3.46%

3.42%

2004

2.68%

1.93%

1.69%

1.74%

2.29%

3.05%

3.27%

2.99%

2.65%

2.54%

3.19%

3.52%

3.26%

2003

2.27%

2.60%

2.98%

3.02%

2.22%

2.06%

2.11%

2.11%

2.16%

2.32%

2.04%

1.77%

1.88%

2002

1.59%

1.14%

1.14%

1.48%

1.64%

1.18%

1.07%

1.46%

1.80%

1.51%

2.03%

2.20%

2.38%

2001

2.83%

3.73%

3.53%

2.92%

3.27%

3.62%

3.25%

2.72%

2.72%

2.65%

2.13%

1.90%

1.55%

2000

3.38%

2.74%

3.22%

3.76%

3.07%

3.19%

3.73%

3.66%

3.41%

3.45%

3.45%

3.45%

3.39%

1999

2.19%

1.67%

1.61%

1.73%

2.28%

2.09%

1.96%

2.14%

2.26%

2.63%

2.56%

2.62%

2.68%

1998

1.55%

1.57%

1.44%

1.37%

1.44%

1.69%

1.68%

1.68%

1.62%

1.49%

1.49%

1.55%

1.61%

1997

2.34%

3.04%

3.03%

2.76%

2.50%

2.23%

2.30%

2.23%

2.23%

2.15%

2.08%

1.83%

1.70%

1996

2.93%

2.73%

2.65%

2.84%

2.90%

2.89%

2.75%

2.95%

2.88%

3.00%

2.99%

3.26%

3.32%

1995

2.81%

2.80%

2.86%

2.85%

3.05%

3.19%

3.04%

2.76%

2.62%

2.54%

2.81%

2.61%

2.54%

1994

2.61%

2.52%

2.52%

2.51%

2.36%

2.29%

2.49%

2.77%

2.90%

2.96%

2.61%

2.67%

2.67%

1993

2.96%

3.26%

3.25%

3.09%

3.23%

3.22%

3.00%

2.78%

2.77%

2.69%

2.75%

2.68%

2.75%

1992

3.03%

2.60%

2.82%

3.19%

3.18%

3.02%

3.09%

3.16%

3.15%

2.99%

3.20%

3.05%

2.90%

1991

4.25%

5.65%

5.31%

4.90%

4.89%

4.95%

4.70%

4.45%

3.80%

3.39%

2.92%

2.99%

3.06%

1990

5.39%

5.20%

5.26%

5.23%

4.71%

4.36%

4.67%

4.82%

5.62%

6.16%

6.29%

6.27%

6.11%

1989

4.83%

4.67%

4.83%

4.98%

5.12%

5.36%

5.17%

4.98%

4.71%

4.34%

4.49%

4.66%

4.65%

1988

4.08%

4.05%

3.94%

3.93%

3.90%

3.89%

3.96%

4.13%

4.02%

4.17%

4.25%

4.25%

4.42%

1987

3.66%

1.46%

2.10%

3.03%

3.78%

3.86%

3.65%

3.93%

4.28%

4.36%

4.53%

4.53%

4.43%

1986

1.91%

3.89%

3.11%

2.26%

1.59%

1.49%

1.77%

1.58%

1.57%

1.75%

1.47%

1.28%

1.10%

1985

3.55%

3.53%

3.52%

3.70%

3.69%

3.77%

3.76%

3.55%

3.35%

3.14%

3.23%

3.51%

3.80%

1984

4.30%

4.19%

4.60%

4.80%

4.56%

4.23%

4.22%

4.20%

4.29%

4.27%

4.26%

4.05%

3.95%

1983

3.17%

3.71%

3.49%

3.60%

3.90%

3.55%

2.58%

2.46%

2.56%

2.86%

2.85%

3.27%

3.79%

1982

6.16%

8.39%

7.62%

6.78%

6.51%

6.68%

7.06%

6.44%

5.85%

5.04%

5.14%

4.59%

3.83%

 

 


[1] Inflation is briefly expressed as positive ∆ MV i.e. increase in Money quantity × Money circulation velocity of a given economy at a particular time. A sharp increase in M results in a great increase in inflation rate. However V is subject to much slower movement thus no substantial inflation occurs without a substantial increase in M. M is a sum total of the currency outside of commercial banks and demand deposits. V refers to the number of times a unit of currency is spent on annual income payments. 

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