By: The Editorial Board – wsj.com – Feburary 14, 2023

The inflation rate for the last 12 months fell to 6.4%, which continues the trend of recent months after it reached a peak of 9.1% in June. But inflation remains stubbornly high and suggests that the Federal Reserve has been right in saying that it has more work to do.

Optimists say roughly half of January’s increase was due to shelter, which is set for decline as rents and housing prices have fallen since the Fed began raising interest rates. But inflation in services less shelter keeps rising fast, and food and energy prices were up 0.5% and 2%, respectively. Strip out food and energy, and so-called “core” prices were up 5.6% over 12 months, which is still too high.

One underlying debate concerns the role of the money supply in inflation. Monetarists like our contributors Steve Hanke and John Greenwood were right in predicting that the peak increase in the money supply (M2) of more than 77% at a three-month rate in 2020 would lead to higher prices with a lag.

But now they’re saying that the sharp decline in the money supply that began last year will lead to rapid disinflation in the coming months and perhaps a recession. Wall Street forecaster Ed Hyman of Evercore ISI and Don Luskin of Trend Macro are anticipating similar inflation declines and are warning about the risk of recession. They note that Milton Friedman said monetary policy works with “long and variable lags” of a year or two.

We admit to losing confidence in M2 as an infallible inflation guide in recent decades. Robert Mundell, Friedman’s peer as a Nobel-winning economist, argued that monetary policy worked much faster—especially through exchange rates. We’ve tended to look at a variety of real-time price signals, including commodities, the dollar and exchange rates, and other asset prices as our inflation guides.

Fed Chairman Jerome Powell has been dismissive of the money supply as a reliable signal as he has navigated the current inflation crisis. He rejects the surge in M2 as the cause of the inflation in 2021-2022, and he’s given no indication that he is paying attention to its dramatic fall in recent months.

But the mavens of M2 were right in predicting the post-pandemic inflation, and they’ve earned a hearing. The January data tells us that inflation is stubborn and it would be unwise to ease up prematurely. But this isn’t an exact science, and the coming months will be a market test for the monetarists and the Fed.

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Source: Inflation Proves Stubborn in January – WSJ