Monetarism for Dummies

July 20, 2026   We all know who said, “Inflation is always and everywhere a monetary phenomenon.” And that’s because we all have that know-it-all friend that’s insufferable at parties. He also likes to use words like convexity and standard deviations.

New Fed Chair Kevin Warsh studied under Friedman, and he's spent years arguing the Fed's biggest post-pandemic mistake was believing monetary policy had nothing to do with money. At the semi-annual Humphrey-Hawkins testimony last week, Warsh criticized the prior dismissal of M2 and argued that paying attention to the post-Covid money surge would have helped the Fed anticipate inflation.

People immediately started sending me M2 graphs. “Look how cool I am! I know about M2 and the St. Louis FRED database! Big words! Fancy graphs!” That guy is a real blast at parties…wait…am I describing…me?

Here’s my take on Warsh’s Congressional testimony: he was hawkish on persistent inflation, but noticeably more nuanced about distinguishing higher prices from an ongoing monetary inflation cycle.

But Warsh has a totally different view on the Fed’s role than Powell did, so I guess it’s time to review how Warsh thinks about inflation and the impact that might have on rates.

Last Week This Morning

• 10T: 4.55%

• 2T: 4.17%

• SOFR: 3.66%

• Term SOFR: 3.62%

• UMich Consumer Sentiment: 54.4 vs. 51 expected

• CPI Inflation Data

  • CPI m/m: -0.4% vs. -0.1% expected

  • CPI y/y: 3.5% vs. 3.8% expected

  • Core CPI m/m: 0% vs. 0.2% expected

  • Core CPI y/y: 2.6% vs. 2.8% expected

• PPI Inflation Data

  • PPI m/m: -0.3% vs. 0% expected

  • PPI y/y: 5.5% vs. 6.2% expected

• Fed Speeches: 

  • Williams: “I expect overall inflation to decline to around [3.25%] percent by year-end, then continue on a glide path toward our 2 percent goal in 2027 and land on target in 2028,”

  • Logan: “I currently believe modestly higher interest rates would better balance the outlook and risks for the FOMC’s dual mandate goals,” …“Every month of above-target inflation has compounded the strain on Americans’ budgets.”

That Inflation Tho!

Tuesday’s CPI was shockingly lower than expected. Forecasters were already expecting a much cooler print, and every single reading was lower than expected.

One print a trend does not make, but I think this has huge ramifications for the Fed.  This reading captured the effects of the ceasefire, and the inflation reversal was so much faster than it was with tariffs.  As the Iran situation oscillates, this should allow the Fed to say, “We have direct evidence that as soon as the Strait of Hormuz opens, pricing eases.  We don’t need to hike, we just need to be patient.”

The market still has an 80% probability of a hike by year end.  And Bloomberg’s eco team has an LLM trained on Fed-speak going back to the GFC.  It is at levels that have always seen hikes within 60 days.  All signs point to at least one hike.

I still don’t believe the Fed will hike, but I do wonder how much of that is a residual overconfidence from a Powell-led Fed.

Warsh is a new variable in the equation, so I thought it made sense to dig into how he might approach monetary policy.

Warsh and Monetarism 

Here’s the graph that gets sent to me the most by readers – the M2 money supply. “It’s going up and right…inflation!"

Here’s my reply, “Then how come we didn’t have inflation problems between 2010 and 2020?”

It’s pretty clear that the inflation we experienced post-covid was the result of a rapid above-trend growth in money supply, not just growth of any kind.  Everyone with a Friedman bumper sticker tends to forget the rest of that famous quote, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

If the money supply is growing faster than the economy, we have inflation.  That’s it. That’s monetarism.

That’s what Friedman and his fellow monetarists believe.  And that’s important because Warsh is a monetarist. Rates, unemployment, output gaps…all downstream effects of money supply, rather than drivers of inflation.

With Warsh in charge, the obvious question then is, “is money supply growing faster than the economy?”

Answer: No. Money is growing at about the speed limit.

Money supply is growing at roughly 4%-5%.  The economy's speed limit is roughly the same 4%-5%. Money and the economy are growing in lockstep.  Compare that to 2020–21, when money supply grew 25%+ against that same 4%-5% speed limit.

What stands out is that the growth has been quietly accelerating for six straight months and starting to exceed the speed limit.  Right now, Jay-Z would say we’re doing 55 in a 54.

Any rate hiking justification is dependent on this trend continuing: if money growth accelerates from here, then tightening is warranted. It hasn't yet, but it’s on Warsh’s radar gun.

More Nuanced Measures

Before you conclude Warsh is just going to stare at the M2 chart, here's the twist: even Friedman gave up on it. In 2003, he told the Financial Times that using the quantity of money as a target "has not been a success" and that he wouldn't push it as hard as he once did.

In 1984, Friedman looked at surging M2 and publicly predicted inflation would come roaring back. It didn't.

He wasn't wrong about the framework; he was wrong about the measurement. The early 80s brought a wave of financial innovation…money market funds…interest-bearing checking…M2 counted all of it as if it were cash in your parents’ pocket. The radar gun said 90 when the car was really doing 60.

The fix has existed since 1980 but almost nobody uses it: Divisia aggregates, which weight each type of money by how spendable it actually is. Cash counts 100%.  A CD or a T-bill, which pays interest and takes effort to turn into spending, counts less. And because I know you’re on the edge of your seat…Divisia was the name of the economist that developed this measure.

The M2 crowd tends to overlook the 2012 period when money supply was growing 2x as fast as it is today.  Would rate hikes in 2012 had made sense?  Please.

In that same time period, the Divisia measures showed money supply growing at just half the rate.

Here’s the bad news: Divisia growth is actually running hotter today than the old school M2 measurement.

So JP, the Fed is hiking then?

Maybe, but one last step before we make that conclusion.

Modernizing Monetarism 

Remember, money growth is only inflationary if it outruns what the economy can absorb. That economic potential is influenced by things like AI and deregulation. Maybe the economy today can soak up more money than before?

Plus, if you’ve been reading this newsletter for a while, you probably recall that I am a big believer in the role that velocity of money plays in the inflation story. If money just sits around, even if there’s more of it, we don’t have inflation.

Here’s the St. Louis FRED velocity graph: 2010-2020 benign, 2021-2023 brutal. Money needs to change hands for us to have inflation.

One of the things I am most interested in under a Warsh-led FOMC is his investigation into more modern data tools. I’ve railed against NFP and the stupid household survey for inflation for years; maybe Warsh will change that for the better.

In a Hudson Bay research piece (A Return to Monetarism) last week by Stephen Miran, Nouriel Roubini, and Peter Ireland, the authors propose a more modern way to measure inflationary pressures that accounts for Divisia money supply, productivity potential, and velocity of money: price gap.

• Positive gap: there's more money out there than current prices reflect, so inflation will accelerate 

• Negative gap: policy is restrictive
  
  

Think of the gap as inflation still in the pipeline. In 2021, it hit 16, signaling up to 16% of catch-up inflation spread out in the following years. Today it sits below 1, less than half a year of normal inflation. The inflation pipeline today is basically empty.

This suggests the economy is currently absorbing the money supply without inflationary pressures.  Rate hikes aren’t necessary and would likely cause damage.

The move so far in price gap has been about normalization. If the trend continues, however, a monetarist FOMC is likely to hike.

I have no clue whether Warsh buys into this framework, but I do believe it will get more consideration than it would have in the past.

The Week Ahead

Quiet week on the data front, but lots of Iran news over the weekend that will likely impact the opening bell Monday.