Growth in the money supply serves as a poor everyday predictor of inflation but becomes a useful early-warning signal when it moves far outside its historical range, according to a new analysis published by the Federal Reserve Bank of St. Louis in November 2026. The study examines whether Milton Friedman's famous assertion—that "inflation is always and everywhere a monetary phenomenon"—holds up as a reliable forecasting tool. The report concludes that money growth and inflation tend to move together mainly during extreme, high-inflation periods, but otherwise tend to drift apart.
The analysis tracked 66 years of quarterly data comparing excess money growth—annualized growth in M2 money supply beyond economic output—against headline personal consumption expenditures inflation, the Federal Reserve's preferred inflation measure. Excess money growth peaked at nearly 93% in mid-2020, unmatched anywhere else in the sample, and PCE inflation followed roughly a year later, eventually reaching more than 7% in mid-2022. Across most of the sample period, though, money supply growth exceeded real GDP growth even as inflation rarely veered consistently above the Fed's 2% target, especially since the early 1990s. Velocity growth—the rate at which money circulates—swung from about negative 23% in mid-2020 to positive 11% by 2023 as the pandemic-era money stock first exploded and then contracted. During the 2008-09 financial crisis, velocity growth collapsed to roughly negative 11% even as excess money growth surged into double digits.
The report cites research from the Bank for International Settlements that investigated the link between excess money growth and inflation across 32 countries using non-overlapping 10-year averages. That study concluded there's a near perfect one-to-one relationship between the two variables when inflation is high, but the relationship is significantly weaker at low to modest inflation levels. The authors note that a well-respected academic monograph on forecasting inflation doesn't reference money growth even once, illustrating why economic forecasters rarely consider it an important indicator of future inflation movements.
The report explains that velocity of money supply—the rate at which money circulates through the economy—can offset changes in money supply growth, nullifying the effect of excess money growth on inflation at ordinary levels. When velocity growth decreases as excess money growth increases, the quantity theory relationship breaks down. In 2008-09, double-digit excess money growth coincided with falling inflation because velocity fell faster than money grew—banks and households hoarded the new money rather than spending it. In 2020-21, by contrast, money growth was so extreme and so directly tied to transfers into household bank accounts that even a sizable offsetting decline in velocity couldn't prevent the subsequent inflation surge. It's precisely when the shock is large enough to overwhelm velocity's usual offsetting behavior that Friedman's rule of thumb holds.
For forecasters, the report concludes that money growth serves as a poor everyday predictor but a useful early-warning signal precisely when it matters most: when its growth rate moves far outside its historical range. Only in rare episodes when money growth turned extreme—the 1970s and again in 2020-21—did the quantity-theory relationship reassert itself. At ordinary levels of money growth, velocity fluctuations swamp the signal, explaining why forecasters have largely set money growth aside as a routine forecasting tool.