M2 Money Supply and CPI Inflation. Part 4

This article concludes the analysis of the correlation patterns between the M2 Money Supply and Consumer Inflation (CPI).  The last of the three types of inflation patterns (time periods with no significant inflation trends) is the subject of analysis here.  The other two types of patterns (inflation surges¹ and disinflation/deflation surges²) were analyzed previously.  The conclusion discusses the correlation patterns for all time periods, looks for any common threads, and identifies important differences across time periods and types of correlation patterns.

Image by Gerd Altmann from Pixabay.

Introduction

The hypothesis we are testing is that inflation depends on nonfinancial corporate credit in a linear manner, expressed in the following equation:³

I = mS + b

where

I = Change in CPI (the Consumer Price Index)

S = Change in the M2 Money Supply

Data

The data sources³ and tables for M2 and CPI are in Part 1.  The timelines³ for the two data sets in Part 1 have coincident timelines and offsets by three and six months out to 24 months for M2 changes coming before CPI ch and vice versa.

The inflation timeline from 1952 through 2022 uses year-over-year inflation calculated quarterly.  Figure 1 shows the inflation graph for the 1952-2022 time period (from Part 1).

Figure 1.  CPI Rolling Four Quarter Inflation 1952-2022 with Significant Changes in Inflation Noted
(Each letter identifies the end of a significant move.  An * identifies the end of an insignificant time period.)

Table 1 shows the data from Figure 1.

Table 1.  Timeline of Inflation Data 1952-2022 (Previously Table 4*.¹)

In Table 1, a black letter identifies a significant positive surge in inflation, a red letter for significant negative surges, and no letter for time periods with no significant changes in inflation.

Significant surges are changes in inflation ≥4% with no intervening countertrend moves >1.5%.

Analysis

There are 13 quarterly timeline alignments examined in each of the 5 time periods:

• M2 Money Supply and CPI Inflation quarters are coincident.
• M2 Money Supply leads and lags CPI Inflation by one quarter (±3 months)
• M2 Money Supply leads and lags CPI Inflation by two quarters (±6 months)
• M2 Money Supply leads and lags CPI Inflation by three quarters (±9 months)
• M2 Money Supply leads and lags CPI Inflation by four quarters (±12 months)
• M2 Money Supply leads and lags CPI Inflation by six quarters (±18 months)
• M2 Money Supply leads and lags CPI Inflation by eight quarters (±24 months)

1Q 1970 – 2Q 1972

Figure 2.  M2 Money Supply and CPI  Inflation 4Q 1969 – 2Q 1972

In this period, inflation changes are in a slight downtrend. M2 money supply changes are in a relatively flat trend.  However, the volatility of the M2 changes is much greater than that of CPI.

Figure 3.  Quarterly Changes in M2D (x) vs. CPI Inflation (y) 4Q 1969 – 2Q 1972

The association (correlation) between the M2 money supply and CPI inflation is moderately negative with coincident timelines during this relatively stable inflation period:  R = –64%, R² = 41%.

Figure 4.  Correlation Between M2 and CPI Inflation 4Q 1969 – 2Q 1972

Figure 4 shows the weakly positive association of M2 changes with inflation changes when M2 changes come 18 and 24 months before inflation (left side of the graph).  R ≤ 41%, R² ≤ 19%.  However, the associations are weakly or moderately negative for all the shorter timeline offsets. These results suggest that up to 19% of CPI change might be caused by M2 change 18-24 months earlier.  However, M2 changes cannot contribute to CPI changes 3-12 months later.

The right side of Figure 4 shows moderate and weak negative correlations when CPI changes come 3 and 6 months before M2 changes. However, there are weak and positive associations for M2 changes coming 9, 12, 18, and 24 months after CPI changes (R ≤ 56%, R² ≤ 27%).  These results suggest that CPI changes cannot contribute to M2 changes 3-6 months later but might contribute up to 27% of M2 changes 9-24 months later.

Caution: causation cannot be confirmed or eliminated without additional information.

3Q 1983 – 4Q 1986

Figure 5.  M2 Money Supply and CPI Inflation 2Q 1983 – 4Q 1986

Figure 5 shows a very slight downtrend for CPI quarterly changes, with one deflationary dip for the first quarter of 1986. The quarterly changes for M2 show a very gradual uptrend. The volatility for the two variables is comparable here.

Figure 6.  Quarterly Changes in FSD (x) vs. CPI Inflation (y) 2Q 1983 – 4Q 1986

This period shows a weakly negative correlation:  R = –38%, R² = 15% for the coincident timelines data.

Figure 7.  Correlation Between M2 Money Supply and CPI Inflation 3Q 1983 – 4Q 1986

There are weak positive associations on both sides.  On the left side, all positive associations are R ≤ 42% and R² ≤ 17%. On the right side. all positive associations are R ≤ 29% and R² ≤ 8%. There are no prospects for any significant or moderate cause-and-effect possibilities between the two variables during this time interval.

2Q 1998 – 3Q 2006

Figure 8.  M2 Money Supply and CPI Inflation 2Q 1998 – 3Q 2006

Figure 8 shows nearly level trends for both variables.  CPI has four deflationary excursions here: 4Q 2001, 4Q 2004, 4Q 2005, and 3Q 2006. The volatility is greater for M2 changes here, except for 2005 and 2006, where volatility is similar for the two variables.

Figure 9.  Quarterly Changes in M2 (x) vs. CPI Inflation (y) 2Q 1998 – 3Q 2006

There is a fragile positive association between the two variables, R = 19% and R² = 4%.

Figure 10.  Correlation Between M2 Money Supply and CPI Inflation 2Q 1998 – 3Q 2006

Figure 10 indicates little association between the M2 money supply changes and CPI inflation for these 102 months.  The highest value of R is 39.5% (R² = 16%) for CPI occurring 24 months before M2.  There is also a noticeable negative association on each side of the graph.

3Q 2011 – 1Q 2020

Figure 11.  M2 Money Supply and CPI Inflation 3Q 2011 – 1Q 2020

Figure 11 shows quarterly CPI inflation changes in a generally level trend. The M2 quarterly changes is in a slight downtrend until 2018, with a dramatic surge in 1Q 2020.  A remarkable point in this graph is that there are nine deflationary quarters.

Figure 12.  Quarterly Changes in M2 (x) vs. CPI Inflation (y)  3Q 2011 – 1Q 2020

This data shows a weak positive correlation for coincident timelines data:  R = –24%, R² = 6%.  This indicates that at least 94% of the quarterly variation in the M2 money supply is not caused by coincident CPI inflation or vice versa.  One outlier point exists in the scatter plot for the M2 money supply surge in 1Q 2020.  If that point is deleted, the result for the trendline equation is y = -0.0417 + 0.0046 and R = –5%, R² = 0.25%.  That would indicate more than 99% of the change in CPI was caused by something other than M2 and vice versa.

Figure 13.  Correlation Between M2 Money Supply and CPI Inflation  3Q 2011 – 1Q 2020

The left side of Figure 13 shows that the maximum association (M2 changes 18 months before CPI) is R = 40% and R² = 16%.  All other positive associations are R ≤ 29% and R² ≤ 8%.  There is also a negative association larger than any of the positive associations, R = –47% and R² = 22%.  This indicates that at least 84% of the changes in CPI were caused by something other than M2.

The right side of Figure 13 has a negative association for CPI changes 3 months before M2 changes.  The other associations are negligible until 24 months when R = 26% and R² = 7%.  This indicates that at least 93% of the changes in M2 were caused by something other than previous changes in CPI.

Conclusion

The conclusion is divided into two sections. First, the analysis results are discussed for the current study of time periods without significant inflation surges up or down. Then, there is an overall summary of associations between the M2 money supply and CPI for inflation/disinflation periods and a look forward to future work.

Patterns of Correlation for Periods without Significant Inflation Surges

To simplify this discussion, the five periods without significant surges in inflation are numbered, as shown in Table 2.  The first period (I) was not included in this study because data for M2 is not available before 1959.

Table 2. Time Periods with No Inflation/Disinflation Surges 1952-1022

There are fewer correlations found in this data than those for other money growth change sources.  The general observations for the four periods analyzed in this article are:

• Inflation volatility quarter-to-quarter compared to M2 is less for II and most of IV.  Otherwise, volatility was comparable.

• There are no moderate or strong associations between M2 money supply and CPI inflation.

Overview of All Financial Sector Debt Spending Data Sets

Let’s review the results for all 18 time periods – positive and negative inflation surges plus the periods without surges analyzed above.  We use the letter designations in Table 1 and the numerical designations in Table 2 to simplify the discussion.

Table 3 summarizes the results for all periods for correlation (association) of quarterly M2 money supply changes with CPI Inflation changes.  In the table, black letters are for periods with positive inflation surges, red letters are for periods with negative inflation surges, and Roman numerals are for periods without surges.

Table 3. Associations Between  M2 Money Supply and CPI Inflation 1959-2022

The associations shown in Table 3 indicate the maximum possible cause-and-effect relationships.  The moderate correlation strength covers the range 50%>R²>25%.  So, for example, R² = 40%, no more than 40% of one variable can result from the other.  However, the lower limit of cause-and-effect is zero, depending on other information in addition to the statistical result.  As stated differently, the cause of one variable is between 60% and 100%, based on factors other than the second variable.

The weak and negligible associations give a more satisfying result.  They indicate that much (more than 75%) of the cause of one variable comes from other sources than the second (weak association), or nearly 100% comes from other sources (negligible).

There are a few possibilities for more than 50% cause-and-effect (significant strength), but the proof is not given without further information.

There are also possibilities for important cause-and-effect relationships between 25% and 50% (moderate strength).  However, additional information is needed in each case to prove that the causations are not lower than R² would indicate.

The most remarkable feature of Table 3 is that the number of events in the weak and negligible classes is much greater than in the moderate and significant classes.  This is more pronounced than for the other sources of money we have studied.

Summary

Next, we will compare and summarize the results we have obtained for associations between changes in the quantity of money and inflation.

Appendix

Below are the data sets for each period without surging inflation or disinflation/deflation. They come from the tables of timeline alignments³ (M2 Money Supply and Inflation: Part 1).

3Q 1983 – 4Q 1986

3Q 2011 – 1Q 2020