Exploring the Connection Between Demand and Inflation, Russian Expansionism, & the Relevance of Money in Informing Monetary Policy.

Here is what we will be getting into today:

1. Uncovering the Real Drivers of Inflation: The Interplay of Markups and Demand.

2. Europe's Advantages in Defending Against Russian Expansionism.

3. Economic Slowdown: Confirmed by Trade Data and Declining Inventories.

4. The Relevance of Money in Informing Monetary Policy and Understanding Inflation.

Let's Dive In!

Newsletter: Economic Forces

Title: Price Theory as an Antidote.
Link: https://pricetheory.substack.com/p/price-theory-as-an-antidote

Here are the key highlights:

• The relationship between markups and inflation has been the subject of recent research, with some sources claiming that markups are the primary cause of inflation. However, when examined through the lens of price theory, this argument is revealed to be incorrect. Price theory provides a disciplined approach to understanding economic topics and can be used to identify causal effects.

• Perfectly competitive firms take the price as given and adjust production based on this price. Their profits are maximized when marginal revenue equals marginal cost, meaning that price will equal marginal cost.

• Firms with market power set their own prices and maximize profits when marginal revenue equals marginal cost, which results in a markup above marginal cost due to the downward-sloping demand curve.

• If markups are rising, it must be due to increasing demand, not rising costs, as perfectly competitive firms would only raise their prices if costs went up, but firms with market power would only raise their prices if demand went up.

• Therefore, rising markups imply that inflation is driven by increasing demand, not rising costs due to supply-side factors or monetary policy. Marginal revenue is always less than price and that if firms maximize profits, then marginal revenue will equal marginal cost. If marginal cost increases, the markup will decrease because the vertical distance between the demand curve and the marginal revenue curve will get smaller.

• Rising markups are consistent with an increase in demand, as people are willing to pay more for each unit of production. Recent inflation has been driven by demand-side factors, such as expansionary monetary policy, rather than supply-side disruptions or higher marginal costs. By understanding the relationship between markups and inflation, we can make informed decisions about how to manage our economy in light of these trends.

Newsletter: Noahpinion

Title: Europe has to stand against Russia.
Link: https://noahpinion.substack.com/p/europe-has-to-stand-against-russia

Here are the key highlights:

• In recent months, it has become apparent that Russia is facing difficulties in the war in Ukraine, with discussions of Ukrainian offensives replacing speculation of Russian ones. The initial invasion of Ukraine was done with a limited number of troops and armor, but Russia has since mobilized a large number of troops, giving them a four-fold advantage over Ukraine. To counteract this, Ukraine has shifted to infantry supported by artillery barrages. However, their efforts are being hampered by Russian HIMARS missile launchers and a shortage of Soviet ammo stockpiles.

• Europe cannot solely rely on the US as a permanent solution to Russian expansionism, as the US may not maintain its current level of support in the future. To ensure its security, Europe must increase its defense spending, build up necessary weapons, and put aside internal disagreements to present a united front against Russia.

• Europe has a significant advantage over Russia in terms of population, manufacturing capability, and political stability, and can defend itself without relying on US aid or Russian energy sources. Germany must also overcome its guilt over its Nazi past and take a leading role in defending Europe. Europe must recognize that it is strong enough to protect freedom without outside help.

Newsletter: Prometheus Research

Title: Prometheus ETF Portfolio.
Link: https://prometheusresearch.substack.com/p/prometheus-etf-portfolio-d6b

Here are the key highlights:

• Stocks and bonds have performed poorly, while gold and commodities have shown better performance due to Chairman Powell's indication that a strong labor market might require more tightening, but that inflation is still the target variable to be controlled.

• New trade data confirms a slowdown in nominal and real economic activity, indicating more weakness as the economy moves towards a potential contraction. Business inventories are also declining, consistent with our business sales tracking and further weakening our monthly monitoring of total investment, which is now in contraction on a nominal basis.

• Our systems have chosen to ride the disinflationary wave by betting on the dollar, which reflects market pricing towards tightening liquidity conditions as Treasury ramps up issuance while reducing bill supply. This allocation has an expected volatility of 8% with a maximum of 10% and the CPI is likely to be the dominant mover next week depending on the surprise in the data.

Newsletter: Institutional Economics

Title: Who forecast inflation correctly? Bringing money back into business cycle analysis.
Link: https://stephenkirchner.substack.com/p/who-forecast-inflation-correctly

Here are the key highlights:

• The recent acceleration of inflation in 2021 and its persistence into 2022 has caused a lot of confusion and concern among policymakers, with some claiming that we do not understand the inflation process.

• However, a paper by Joshua Hendrickson for the Mercatus Center shows that a simple model of inflation based on Divisia M2 growth does a good job of forecasting the acceleration in the inflation rate in the United States. This highlights that we can still understand and forecast inflation, even in this confusing environment.

• Additionally, monetarists like Scott Grannis and Tim Congdon had anticipated higher inflation rates prior to this due to observed growth in M2 and trends in money demand. This further emphasizes the importance of money in understanding inflation.

• The workhorse New Keynesian model that informs monetary policy has been ignoring money, but a paper by Carl Walsh with Roberto Billi and Ulf Sderstrm on the role of money at the zero bound in a New Keynesian model suggests that it is making a comeback and is crucial to informing monetary policy decisions.

• Unfortunately, Canada has recently announced its intention to discontinue issuance of real return bonds (RRBs), which will mean we will no longer have access to these market-based implied inflation forecasts. This will make it more difficult to make informed decisions about monetary policy.

• The global pre-pandemic low inflation environment presented a challenge for inflation-indexed bonds, and the recent high inflation environment has caused investors to take a hit in terms of higher real yields. Despite this, it appears that policymakers are not valuing the information about future inflation contained in inflation-linked securities.

• Policymakers should be looking to expand and deepen market-based insights into future inflation to avoid forecasting failures and provide investors with more reliable information when it comes to investing in these types of securities. Policymakers must recognize the value of these bonds and take steps to ensure they are being used effectively and accurately.

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