The two "regimes" of inflation and their causes

Inflation is debated among economists, and many are those who have missed its anticipation. Recent reports from several institutions have thus re-examined the link between the money supply and inflation. Central banks thus admit half-heartedly that rates have a real effect on prices. But from the statistical data an observation seems to emerge. In addition, the Bank for International Settlements (BIS) specifies for example the following: “There is a statistically and economically significant positive correlation between excess monetary growth in 2020 and average inflation in 2021 and 2022”.

The old currency devaluation debate

THE link between inflation and money supply is a long debate. A previous article had already led us to discuss the link between inflation and the money supply. This debate is so entrenched that it is found explicitly as early as the Middle Ages. Nicolas Oresme (1321-1382) already spoke in 1360, in his treatise From Monetathe need not to devalue the currency. Indeed, this French master of theology defended the idea that the currency does not belong to the King but to those who use it. Therefore, if usury was badly perceived at the time, devaluation was just as bad.

“It is for this reason, and so that the prince cannot maliciously pretend that the mutation of the proportion of currencies has the cause indicated in the present chapter, that it falls to this community alone to appreciate if and when and how and how far this proportion should be changed, and that the prince should in no way usurp this right. »

Nicolas Oresme (1321-1382), treatise De Moneta, chapter X, around 1360.

Currency devaluation is therefore not a new debate. Also, inflation is the mechanism by which the value of money (the amount of goods and services that can be purchased with money) is reduced.. Inflation is often referred to as a “hidden tax”. And for good reason, it is often difficult to find a “guilty” or a person to whom to attribute this devaluation. Let us also quote Nicolas Oresme, who qualifies the princes (political power) in the following terms: “But still the prince, by this means [de la dévaluation]can acquire for him the money of others”.

THE “two regimes” inflation

Here we will focus on two successive reports from the Bank for International Settlements. Thus, a first report from January 2023 devotes the study to “two regimes” of inflation. The second report, recently published in March 2023, provides more details. There would thus be a “low” inflation regime and a “low” inflation regime. This quite accurately corresponds to the abrupt behavior of inflation, which alternates between these different long-term regimes.

  • We distinguish a first regime “low inflation”. In this regime, inflation is “self-regulating” and it results in price changes between sectors that are not correlated with each other.
  • Then, we distinguish a second regime “high inflation”. In this regime, inflation is linked between the different sectors of the economy and results in increases in the prices of energy or food. So, “wages and prices are more closely linked, and inflation is particularly sensitive to changes in key prices, such as those of food and energy, as well as exchange rate fluctuations”.

These two diets have distinct causes and implications. Subsequently, a remark from second BIS report catches our attention… “After all, Volcker (1983) and subsequently Greenspan (1996) defined price stability as a situation in which the rate of inflation has no significant influence on behavior – broadly analogous to our low inflation regime”.

Growth in the quantity of money and inflation. Graphic according to the BIS. Source : Does money growth help explain the recent inflation surge? (

The real monetary link

What this study shows is that inflation does not spread instantly. It takes years to do so. Indeed, the January 2023 Bank for International Settlements Bulletin shows the following empirical findings.

  • Firstly, “the strength of the link between monetary growth and inflation depends on the inflation regime: it is one to one when inflation is high and virtually non-existent when it is low”.
  • Moreover, “an acceleration in monetary growth preceded the surge in inflation, and countries with the greatest monetary growth experienced significantly higher inflation”.
  • Finally, “Examining money growth would have helped improve post-pandemic inflation forecasts, suggesting that its information value may have been overlooked.”

Finally, monetary creation, induced or not by central banks, is not a cause of inflation when inflation is low. On the other hand, monetary creation is an explicit cause of inflation when the latter is high. Inflation being necessarily financed by a larger quantity of money (see Fisher’s relation below). The chart below clearly shows that excessive monetary creation is directly linked to excessive price increases when inflation is high.

Link between inflation and money supply according to the inflation regime. Graphic source: Does money growth help explain the recent inflation surge? (

The study also specifies that monetary policy loses price flexibility with low rates. “Another concordance is that monetary policy loses momentum when nominal interest rates are very low”.

The actual causes of inflation

If the money supply is a decisive criterion in a regime of high inflation, we can observe effective mechanics. Thus, the high inflation regime is also characterized by high price volatility. That is to say that the evolution of prices is unstable (chaotic), and certain sectors are more exposed than others. The graphic below shows, by sector of the economy, the sectors most sensitive to price variations. As a result (and unsurprisingly), we see that food services are the most sensitive (in terms of price) to the food and beverage sector.

Sensitivity of sectors of the economy to price variations compared to other sectors.

Another feature of the high inflation regime is that energy and commodity inflation does not converge to core inflation. On the contrary, it would rather be (as we are seeing today) underlying inflation (ie excluding commodities and energy) which is gradually converging towards primary inflation.

Next, a high inflation regime is also characterized by greater wage/inflation sensitivity. This can be explained both for cyclical reasons but also by Phillips’ relationship. Indeed, the Phillips curve tends to show that high inflation is often synonymous with low unemployment. This implies upward pressure on wages and therefore a risk of an inflationary spiral.

The Old Relationship by Irving Fisher

Fisher’s relation is very famous in economics. It shows that the GDP (ie the wealth produced in a year) is equal to the currency exchanged in a year. With Q the quantity of goods and services, P the price of goods and services, M the money supply, V the velocity (speed of circulation of money).

Q x P = M x V

The rise in price P, at a constant quantity produced, is therefore induced either by the increase in the money supply M, or by the increase in the speed of circulation V. The speed of circulation of money is a good indicator of economic dynamism. However, we observe in recent years that the velocity has not increased, on the contrary, it has decreased.

Velocity for the M2 money supply for the United States. Source : Velocity of M2 Money Stock (M2V) | FRED | St. Louis Fed (

Under these conditions, we understand that the essential cause of high inflation is necessarily the growth of the money supply. For if the speed of circulation of money continues to fall slowly, the quantity of money in circulation has increased considerably in recent years. To date, the velocity is 1.25. In other words, each dollar is traded an average of 1.25 times per year.

Finally, it should be noted that the decrease in the speed of circulation of money is characteristic of a less dynamic economy. That is to say that any new creation of money will have less influence on production. This may also reflect, without an increase in velocity, that inflation can only persist if monetary creation remains sustained.


In conclusion, the latest studies relating to the money supply / inflation causality show some interesting statistics. The first observation is that this causality is very effective today. Nevertheless, inflation and money supply remain intricately linked. Two cases can therefore be distinguished:

  • The money supply is all the more decisive for inflation when monetary creation is strong.
  • The money supply is all the more decisive for inflation when inflation is high. It is the scheme of “high inflation”Or “high inflation”.

Conversely, when inflation is moderate, there is little connection between the money supply and inflation. The second comprehensive BIS report explicitly shows the actual characteristics of a high inflation regime. Thus, in a regime of high inflation, the link between inflation and wages increases (linked to the Phillips curve). In addition, price volatility is greater and the different sectors of the economy see the evolution of their prices linked from one sector to another. In other words, inflation “self-feeding”. Furthermore, high inflation also translates into a persistence of this inflation rate and more often a convergence of underlying inflation towards primary inflation.

This, according to the studies mentioned, clearly reflects the real links between inflation and money.

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