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Narrowing the money supply doesn’t stop inflation

We have been living under the threat of long-term inflation for several months, and in the context of the suffocation of the cheap money market, this is not surprising. In recent days, information has emerged about the intention of some central banks to restrict the money supply, but the measure will not have the expected impact in reducing prices.

Narrowing the money supply doesn’t stop inflation. The inflation rate reached record levels this summer in most countries of the world. Flooding the markets with cheap money and shrinking activity in most economic sectors have inevitably led to the rising inflation rate.

In this context, some voices in the area of public finances are asking us to stay calm because the inflation we are observing is only transitory. In principle, when making these claims, they are taking into account two elements that have the potential to stabilize markets:

– The expansion of trade has been generated by the increase in demand caused by the lifting of restrictions related to COVID-19 and will decrease in the next period; After lifting the restrictions, people used their savings and began to consume aggressively, but the decrease of their savings and the uncertainty of the future will lead to a natural reduction in demand;

– The increasing probability that central banks will change their policy and act to reduce the money supply. In this regard, some central banks have already announced measures that will reduce the amount of money on the market, which will lead to higher capital costs.

In a normal economy these two elements would be sufficient to reduce the level of inflation. Unfortunately, our existence continues under the spectrum of the pandemic and the threat of wave 4 changes the analysis data.

How happened to the prices

We have all found that store prices have risen significantly in the last year. We have also been bombarded for months with articles announcing unprecedented price increases. These price increases were to be expected amid the sharp increase in demand and the difficulty of adjusting production flows. Obviously, as the production costs increased and the markets were invaded with cheap money, prices remained at high levels.

As the economy recovers, the expectation would have been, for the  prices to return to pre-pandemic levels. This would have happened if producers had trusted the evolution of the economy and started acting again according to economic logic. Unfortunately, amid uncertainty about future developments in the economy, market players have raised prices dramatically and tried to maximize the value of each transaction. Basically, the economy has moved from an area of ​​sold volume to one of ​​value per unit. The truth is that we cannot condemn companies for this behavior. Increasing the level of production, in order to reduce market prices, involves additional costs for raw materials and employees. This is linked to uncertainty about the level of demand, if  4th pandemic wave will be one with restrictions.

Narrowing the money supply doesn’t stop inflation

We estimate that prices will remain high and that narrowing the money supply will not cause sellers to lower prices. After two years of restrictions, companies are operating under potential and there are no prospects of seeing a change soon. The pandemic has not said its last word and the bidding agents will resist the reduction of prices. The threat of a new COVID-19 wave will make world suppliers fear new restrictions and falling demand. Most sellers will seek to maximize their sales value and obtain the resources necessary to survive an uncertain future.

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