Inflation is not a virus, and it's not going up

Inflation is not like a virus that spreads through a population. A rising price in one part of the economy cannot "infect" a price in another part of the economy. A currency doesn't just "catch" inflation because oil prices go up or a drought causes wheat prices to rise. Inflation is the result of an imbalance between the supply of money and the demand to hold it. It's a monetary phenomenon, as Milton Friedman taught us. And it generally results in a rising price for most goods and services.

The reason inflation appeared to rise last month, as the August CPI report implied, is not because of a monetary imbalance. As the charts below will show, the bulk of the apparent rise in inflation can be traced back to the way the BLS calculates inflation in the housing sector. There's another factor at work as well: the BLS can and does make mistakes, and numbers are typically volatile from month to month. Seasonal adjustment factors can be off and in need of revision. Consumer preferences for many goods change as prices change, but the BLS is slow to pick that up. The change in one month's number does not reliably mark a change in trend.

Chart #1

The Producer Price Index for Finished Goods (Chart #1) is a great illustration of the rather explosive inflation episode which the economy experienced from early 2021 to mid-2022. Prices were rising slowly from 2015 through 2020, then suddenly rose by more about 27% from early 2021 to mid-2022, only to once again resume a slow rise from mid-2022 through today. The fuel for that price explosion was a $6 trillion increase in the M2 money supply, a subject I've covered extensively in prior posts. From mid-2022 to August 2025, prices have increased at an annualized rate of only 1.4% with little or no sign of any meaningful acceleration. The return to low and relatively stable inflation was preceded by a dramatic contraction in M2.

Chart #2

The Final Demand version of the PPI (Chart #2) shows the same pattern. Although it rose at an annualized rate of 2.2% over the past 3 years, it is up at only a 1% annualized rate in the past six months.

Chart #3

Oil prices (Chart #3) show a rather sharp increase from 2021 through mid-2022, but they haven't increased at all since pre-Covid times. Since mid-2022, oil prices have actually fallen by 40%! Non-energy commodity prices have fallen by almost 10% since March '22. If inflation is on the rise, someone forgot to tell the commodity markets.

Chart #4

Chart #4 shows that the BLS's calculation for housing inflation today (which they call Owner's Equivalent Rent, or OER) is closely related to the year over year change in national home prices from 18 months prior. Today, home prices nationwide are barely increasing and are very likely to decline. Yet the BLS calculates that housing-related costs rose 4% in the past year. 

Chart #5

Chart #5 looks more closely at the behavior of housing inflation according to the BLS. In the past month, BLS calculates that OER rose at a 4.7% annualized rate, and is up at a 3.9% annualized rate over the previous 3 months. At a time when national home prices are on the verge of falling (and rents are flat to down), the BLS figures that housing inflation is accelerating! Trump is right to want a change in BLS leadership.

Chart #6

Chart #6 shows the 6-mo. annualized change in the CPI versus the ex-shelter version of the CPI. Without OER inflation, the CPI has been increasing at about a 2% annual rate for the past 3 years, and the rate of change has actually fallen to a mere 1.7% over the past six months. This means that the uptick in CPI inflation in August was driven by a big increase in the OER component of the CPI, as shown in Chart #5. 

Chart #7

Chart #7 shows the ratio of M2 to nominal GDP. I think that's a good proxy for money demand. Thanks to a big slowdown in M2 growth over the past three years, the amount of readily spendable money in the economy (M2) is almost back to pre-Covid levels. Excess money has been absorbed, and money demand is stabilizing. Thus, there is little or no reason to worry that inflation is coming back to haunt us.