How and why does the inflation of Western countries remain so low?

M x V = P x T

Money supply x Turnover rate = prices x transactions

The above is not a natural law but an accounting/mathematical data.Whatever happened, the balance above should always be in balance.

We know with certainty that money supply has increased sensibly over the last few years and that the number of transactions (of which we may assume that they are proportionally dependent on the prosperity that is produced) has not increased to the same extent than the money supply.

This means that the velocity of circulation should have fallen spectacularly or that there has been inflation.The rate of circulation can only fall when individuals have large amounts of cash and then store them under mattresses, safes or cellars or when financial institutions have their assets at the ECB, BoE, Fed or BoJ. We can make a reliable assessment that this is only a marginal part of why the above balance should still be balanced.

So the prices must have risen anyway… Why is this not reflected in the inflation rates?Simply because the prices of those products that have risen are not taken into account when calculating the “official” inflation rates.

What prices have risen???

The prices of shares, real estate or bonds have risen enormously in recent years, but they do not count towards the calculation of inflation rates.

There are several reasons for this, but the most important is Quantitative Easing by the European Central Bank (ECB).This means that the ECB buys debts from companies and debt is an inflationary phenomenon.

But there is much more to play.In the past, inflation was crawling because in times of boom the production capacity became full. If you wanted to attract employees, you had to pay a higher salary. For example, to buy semi-finished products as a company, you had to bid more to get the first one delivered. That pushed the wages and prices up and that led to inflation.

Now you can always go out to producers in another country.We live in a world market. If the apple harvest fails here, we will buy them in any other country. The result is that prices are barely rising.

I also heard recently that there is so much savings, that by the law of supply and demand, the compensation for that money has become very low.

Well, Maarten, this is the question of 10,000 billion!

No coherent answer has been known.And I am not a macroeconomist (specialist of large economic systems as opposed to corporate economists). But I have a few suspicions.

  • There is inflation, and even strong inflation, but in the markets for investment products.

Take a look at the soap bubbles of the stock markets, bond markets, the real estate, investments in art, even wine etc… How has all that money, injected by central banks (FED, ECB, Bank of Japan) ended up there? And not in the real economy it was intended for?

  • Wage inflation is greatly reduced by migration from jobs to the low wage countries (and when wages rise, they go to the next tranche of low wage countries), through automation and through the weakening of trade unions.
  • The sharp inflation of the years 1970 was successfully fought by Paul Volcker (FED) at the end of the years ‘ 70, and has never been raised again.
  • Have we succeeded in creating expectations that inflation never flares up? Has one been “too” successful? (Of course, there where a little inflation (2%-3%) Has good sides, inflation of 6.8 or 10% per year is far too much).

    Are these indeed valid factors?If so, what is their interplay? Engaging, but I can only leave the question open.

    Thanks for a good question, Maarten!

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