January 15, 2025 | Read Online

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"Inflation is always and everywhere a monetary phenomenon."

— Milton Friedman

Tariffs will make prices go up — and inflation go down?

In the same talk that Milton Friedman famously declared that inflation is strictly a "monetary phenomenon," he also defined that phenomenon as a "steady and sustained rise in prices."

Much of the recent fretting over tariffs suggests that we may have forgotten the "sustained" part — and maybe even what inflation really is.

I don't think anyone would argue with economist Lawrence White's definition of inflation as "an ongoing rise in the general level of prices."

Tariffs, however, create a one-time increase in some prices — and therefore, by the logic of White and Friedman, cannot be inflationary.

If anything, they're likely to be deflationary.

Let's start from the beginning.

When Friedman said that inflation is "always and everywhere" about the supply of money, he was making an empirical observation.

"What he meant was that sustained inflation has historically always been due to sustained money supply growth," White explains, "not to sustained velocity growth or sustained negative growth in real income."

In other words, "putting more dollars in circulation dilutes the purchasing power of each dollar."

Friedman's observation was simply that countries that experienced high inflation were invariably countries that had put too much money into circulation.

(An observation near and dear to every Bitcoiner's heart.)

This relationship between inflation and the supply of money is helpfully intuitive: Prices rise when there is more money chasing the same amount of goods.

And if that's all there is to it, then the stubbornly high inflation that the market so worries about should have an easy fix.

"Achieving zero inflation," White says, "merely requires the central bank, which controls the money supply, to refrain from expanding the money supply too rapidly."

But I don't blame anyone for thinking it can't be that simple, because when the one person who controls the money supply (Chair Powell) talks about inflation, he talks about everything other than the supply of money.

In his most recent press conference, for example, Powell discussed the outlook for inflation in terms of GDP growth, interest rates, wages, the job market, housing, food and gasoline prices, and the cost of insurance.

This makes monetary policy sound very complicated, which I'm not sure it should be because all of those things are arguably downstream of the supply of money — over the long run, the only way for prices to go up in the aggregate is for the Fed to supply more money.

Friedman's all-important supply of money, however, got only the most oblique of mentions by Powell: "We also decided to continue to reduce our securities holdings."

Reducing its security holdings is how the Fed takes money out of the economy — and that might be all we really need to know about the outlook for inflation.

A good way to illustrate this is by thinking about the implications of a new tariff on, say, televisions.

"If the price of TVs goes up and the price of everything else stays the same," the economist John Cochrane writes, "how do we have enough money to buy more of everything? Obviously, (and very loosely speaking) someone has to give us more money to be able to pay the higher prices for TVs and the same price for everything else."

That someone would be the Federal Reserve — which is why Friedman reasoned that inflation is always a monetary phenomenon.

Cochrane used the TV example to explain why supply shocks on their own are not inflationary, but his conclusion applies equally to tariffs: "A supply shock only causes overall inflation if monetary and fiscal policy respond to the supply shock by increasing demand."

In the absence of any such response, tariffs should (at the margin) be deflationary.

"Tariffs raise a little bit of revenue," Cochrane explains. "To the extent that the government doesn't spend more, and to the extent that the tariffs don't reduce income too much, [this] extra revenue helps to pay debt and avoid inflation."

President-elect Trump made this a little more explicit this morning in announcing his "External Revenue Service," the name of which implies that the ERS will be collecting taxes from foreigners in the same way the IRS collects them from natives.

This is just branding, of course, but even critics of Trump's tariffs describe them as a tax — and no one has ever thought that taxes are inflationary!

Today's euphoric market reaction in everything from Home Depot to Fartcoin (following a slightly better-than-expected CPI report) is a reflection of how pervasive inflation worries have been.

This has been driven in part by tariffs, which do seem like something to worry about — Cochrane says tariffs are "a terrible economic policy for lots of reasons."

But inflation is not one of them.

— Byron Gilliam

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Noelle Acheson @NoelleInMadrid

So, the US yield drop and the crypto price bump is really nice 'n all, but the CPI data wasn't *that* great – it doesn't guarantee more rate cuts in coming months.

It does suggest that PCE could be soft, which would be good – but we still have many signs that inflation is not… x.com/i/web/status/1…