Money Aggregates, Debt, Pent-Up Demand, and Inflation: Evidence from WWII

Posted on May 26, 2021 by Florian Buschek

From Federico S. Mandelman, Federal Reserve Bank of Atlanta. Very nice written paper.

The car example probably looks familiar.

Summary:
The COVID-19 pandemic produced a massive decline in U.S. consumption in 2020 and
swift fiscal and monetary policy responses. After growing at a rather steady 5 percent
rate for decades, the money supply (M2) increased 25 percent over the past year
alongside unprecedented fiscal support, raising some inflation concerns. Concurrent
with the reopening of the economy as vaccines roll out, this article derives some lessons
from the U.S. experience during and after WWII. The debt-to-GDP ratio increased from
40 percent to 110 percent because of the war effort. Most of it was financed by Fed
debt purchases, through a de facto yield curve control that held down short-and longterm interest rates. The money supply doubled in size, but inflation was muted during
the conflict as private consumption demand was severely restrained: factories were
fully devoted to the rearmament effort, food was rationed, and residential construction
was practically prohibited. Households’ saving boomed as a result. After the war, swift
pent-up consumption demand culminated in a short-lived spike in inflation from 2 percent
to 20 percent in 1946–47, which quickly returned to 2 percent in 1949. Contractionary
monetary and fiscal policies, along well-anchored low inflation expectations inherited
from the Great Depression, appeared to have contributed to rapid disinflation. I also
discuss the experiences of Japan and Europe in recent decades.

  1. The money supply has increased 25 percent in 2020, raising some inflationary concerns.
    This article derives lessons from the U.S. experience during and after WWII.
  2. The war effort caused the U.S. debt-to-GDP ratio to increase from 40 percent to 110
    percent, most of it financed by Fed treasury bond purchases. The money supply doubled as
    a result, but inflation was muted, with households mostly saving this windfall. Consumption
    demand was suppressed as factories were devoted to the rearmament effort, food was
    rationed, and private construction was halted.
  3. Once the war ended, pent-up consumption demand led to the inflation rate spiking
    from 2 percent to 20 percent in 1946–47. However, it quickly stabilized in 1949, amid
    contractionary policies and well-anchored inflation expectations inherited from the
    Great Depression.
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