--Trends Global, Dec 2015.
As Krugman might say, "...it's in the market, stupid." The most influential economy in the world is poised to raise interest rates, but not because of inflation. Central banks in major parts of the world are still at the zero bound, and core prices are behaving as they should when targeted only because liquidity is trapped on balance sheets as inventory. What happened? Why did monetary easing take half a decade to jump-start the US dollar economy? The answers are common knowledge: banks bought banks with the money, main street lending didn't increase, dealers expanded balance sheets, corporate savings stayed high, investment stayed low; and only now, six years later, is money supply warming up wages and consumption, if it isn't fiscal expenditure.
Economists have been discussing causality (or lack thereof) between money supply and prices for the entire last century (see here in the context of viable central bank tools); but, theoretically, the accounting identity MV = PY is supposed to remain valid in the long-run--more dollars chasing the same goods push prices up. And this is exactly why central bankers should be worried, and interest rates could have gone up earlier. Today the relationship between money supply and output is like nothing it has ever been. By traditional measures, money velocity relative trend has all but stopped. To visualize this recall the chart from Friedman's 2004 article, "The Fed's Thermostat" (now you have to sign-in to read it, so see both of his charts below). His somewhat concessionary admonition, that central bankers since the late 80's had done a better job by targeting inflation, was contingent on a trend-bound money velocity indicator.
Here is a remake of the same chart using current data (a remake of his other chart is also available below).
