What you’re not hearing about the shrinking money supply and the prospect of deflation

The worst of the historic M2 contraction is now almost a year in the past, so the year-on-year growth rate is nearly back to flat. The model link between M2 growth and inflation was extremely strong on the way up, and perfectly called the top. On the way down the model has correctly called the great disinflation, but called for more than we got. The predicted downright deflation seems unattainable with CPI stalled near the Fed's target for seven months. The model has lost power, with its R-squared falling from 0.9 to 0.7. Using data only since the top in inflation two years ago restores the R-squared, but the model no longer calls for deflation, only about another percentage point of disinflation before a return to target. If deflation is off the table, a major risk to sentiment is removed. But so also is a source of reparations for the cumulative damage of three years of intense inflation.