(Kitco News) - The question of what causes inflation, defined as a general increase in prices, is salient in 2022 given the year's high CPI numbers. In June of this year, inflation hit a peak of 9.1 percent, a rate unseen since the late 1980s.
When it comes to the question of causation, Steve Hanke, Professor of Applied Economics at Johns Hopkins University, argued that changes in the money supply drive inflation.
"We know there are lags between changes in the quantity of money and economic activity," he said. "If you increase the money supply, you get essentially a proportional increase in inflation."
John Cochrane, Senior Fellow at the Hoover Institution, argued that taxation and government spending are at the root of inflation.
"I look at the primary cause of our current inflation being that $5 trillion deficit, no matter how it was financed," he said.
Cochrane's upcoming book, A Fiscal Theory of the Price Level, delves into his argument that inflation can be laid at the feet of government taxing and spending decisions.
Hanke and Cochrane spoke with David Lin, Anchor and Producer at Kitco News.
A Fiscal Theory vs. Monetarism
Cochrane claims that prices adjust until the government's real debt equals the present value of all current and future government surpluses.
"The bottom line is that you get inflation when there's more government debt than people think the government will pay off over decades," he said. "So you can run big deficits if people think the government has a way to pay it back."
He added that if taxpayers anticipate future tax hikes, then they will save accordingly, reducing demand and causing inflation to go down.
"If the government prints a lot of money and gives you money, but says [it'll] come back next year with a lot of taxes, you hang onto that money so you can pay those taxes," he said.
Hanke claimed said that in explaining inflation he prefers to examine the M2 money supply, a measure which includes currency in circulation, checking deposits, and savings deposits.
"I'm just looking at M2," he said. "We still have persistent inflation in the system that's coming down… [My co-author and I] think by the end of 2023, [inflation] will be down around 5 percent. And then it might fall very fast, if this contraction in the money supply continues on a sustained basis."
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Fed Failures
Despite their differences over the causes of inflation, both Cochrane and Hanke agreed that the body tasked with policing inflation, the U.S. Federal Reserve, had failed to reign in high inflation.
"[The Fed] has got a staff of thousands of PhD economists," Cochrane said. "And they could not see 8 to 9 percent inflation coming, they denied it was on its way for a full year… So an institution whose job it is to see inflation coming, and to know something about inflation, missing an 8 to 9 percent inflation, and not seeing it for a whole year, that's like Pearl Harbor."
Hanke suggested a political reason for Fed failings, suggesting that Fed economists reject monetarism and the quantity theory of money that it is associated with.
"There are 416 economists at Fed headquarters," said Hanke. "The Democrats outpace the Republicans 48.5-to-1, and Milton Friedman and the quantity theory of money happen to be enemies of the Democrats."
Inflationary Outlook
Both Cochrane and Hanke said that inflation will likely fall further in 2023.
"I'm guessing [inflation will go to] 4% and then something bad will happen. The only way it will get temporarily to 2% is if we have a terrible recession," Cochrane said.
Hanke predicts that inflation will target 5% by the end of 2023.
To find out Cochrane and Hanke's recession outlook, watch the video above.
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