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NOV 4, 2023

The Federal Reserve’s Initial Pandemic Response: A Precedent of Caution or Missed Signals? 🤔

by Spektre, Spektre | SKTR

An Analysis of M2 Supply and Inflation Over the Past 2 Years 🧵Part 1/2

An Analysis of M2 Supply and Inflation Over the Past 2 Years 🧵Part 1/2

The Federal Reserve’s Initial Pandemic Response: A Precedent of Caution or Missed Signals? 🤔

Around 2020, as the graph illustrates, there was a dramatic increase in M2 money supply growth, which likely corresponds to the global response to the economic impact of the COVID-19 pandemic.
Governments and central banks around the world injected a substantial amount of liquidity into the economies to support businesses and individuals affected by lockdowns and other restrictions.

How Increased M2 Affects Inflation:

1. Demand-Pull Inflation: 💸
When there is more money circulating in the economy, consumers typically have more to spend. This increase in demand can lead to demand-pull inflation, where prices rise because demand outstrips supply.
2. Cost-Push Inflation: ⬆️
As businesses see an increase in demand, their costs may also rise due to increased prices for raw materials and components, especially if the supply chains are disrupted. This can lead to cost-push inflation.
3. Expectations of Inflation: 🔮
If businesses and consumers expect that prices will rise due to the increased money supply, they may adjust their behavior accordingly. This can create a self-fulfilling prophecy where expectations of inflation lead to higher prices.

Effects on People and Businesses:

1. Savings and Investments: 🏦
As inflation rises, the purchasing power of money decreases. This devalues savings over time, which can be harmful to retirees and others on fixed incomes. Conversely, it can benefit borrowers by reducing the real value of the money they owe.
2. Cost of Living: 🛒
For individuals, the cost of living can increase as prices rise. This can be particularly problematic if wages do not keep pace with inflation, leading to reduced purchasing power.
3. Business Planning and Investment: 📊
For businesses, rapid changes in the money supply and subsequent inflation can make planning and forecasting more difficult. Uncertainty can lead to reduced investment in capital projects and hiring.
4. Supply Chain and Inventory Levels: 📦
Inflation can affect supply chains and inventory management. Businesses may stockpile goods in anticipation of higher prices, which can further exacerbate supply shortages.
5. Interest Rates: 💹
Typically, central banks may raise interest rates to combat inflation, which affects both people and businesses by increasing the cost of borrowing.

Practical Explanations:

- Short-term vs. Long-term Impact: ⏳
In the short term, the increased M2 supply can stimulate economic activity and potentially lead to economic recovery from recessions. However, in the long term, if the growth in the money supply greatly outpaces economic growth, it can lead to inflationary pressures.
- Sectoral Impacts: 🏭🏥
Not all sectors are affected equally by inflation. For example, sectors like technology and healthcare may continue to thrive due to innovation and demand, whereas sectors heavily reliant on raw materials may struggle with rising costs.

Insights:

The velocity of money 💨 is a crucial component here. If the money supply increases, but the velocity (the rate at which money is exchanged in an economy) decreases because people are not spending (perhaps due to lockdowns or economic uncertainty), then the inflationary impact might be muted initially. However, once the velocity picks up, inflation may also rise rapidly.
In practice, managing the money supply is a delicate balance. Too little growth can lead to recession, while too much can lead to inflation. Finding the middle ground is the central challenge for policymakers.
In summary, the spike in M2 supply growth likely helped prevent deeper economic contractions during the initial phases of the pandemic but has also contributed to the inflationary pressures observed in the subsequent years.
The full effects on people and businesses depend on a range of factors, including wage growth, the responsiveness of supply chains, and policy measures taken by governments and central banks to manage inflation.
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