Bitcoin & Inflation:
Missing Links in Satoshi’s Vision
Vanquishing Inflation…
When promoting his creation, inflation was a main focus for Satoshi Nakamoto, the anonymous creator of bitcoin. His posts read “escape the arbitrary inflation risk of centrally managed currencies” as he pointed out “bitcoin's total circulation is limited to 21 million coins”. Emphasizing bitcoin’s limited supply in relation to inflation alludes to the view that inflation is caused by an increase in the quantity of money; for example, when governments add money to circulation by creating currency. Bitcoin’s supposed anti-inflationary aspect is based on Satoshi’s view that once all 21 million coins are created (mined), they will not lose value from an increase in supply.
Missing Link
Perhaps the most glaring issue with Satoshi’s design is that a relationship between money supply and inflation has not existed for decades. Researchers have been unable to find a link between money aggregates and prices since at least the 1990s. Multiple studies on the link between money supply and inflation were published before Satoshi created bitcoin. However, in over 500 emails and forum posts, Satoshi does not reference any sources of empirical economic data.
Equation of Exchange
Surprisingly, the economic theory bitcoin may be most related to, the monetarist quantity theory of money, is never directly mentioned within the forum threads. Milton Friedman, the most prominent monetarist, said inflation is always caused by an excessive rise in money supply. Though money aggregates were linked to inflation in the past, the relationship broke down by the 1990s, leaving bitcoin’s creator appearing unaware his views may not be accurate.
Milton’s Monetary Rule…
Monetarism states that money supply must increase along with economic growth for price stability and to avoid recessions. In fact, increasing money supply was so central to monetarism that Friedman proposed requiring the Fed to annually increase the money supply at a rate matching GDP growth. Capping the number of bitcoins conflicts with this aspect of monetarism. Satoshi seems not only oblivious to the lack of a relation between money supply and inflation, but also of this key element of the economic theory bitcoin appears to be based on. In early discussion threads, at least two forum members urged Satoshi to change the protocol so more than 21 million units could be created. Satoshi brushed aside the suggestions.
August 17, 2022
Sources on inflation and money supply:
(Published before Satoshi announced bitcoin in 2008)
Batini, N., Jackson, B., & Nickell, S. (2000). Inflation dynamics and the labour share in the UK.
Bank of England, External Monetary Policy Committee Unit, London, External MPC Unit Discussion Paper No. 02.
Borio, C. E. V., & Filardo, A. (2007). Globalisation and inflation: New cross-country evidence on
the global determinants of domestic inflation. Bank for International Settlements, BIS Working Paper No. 227.
Dwyer, G., & Hafer, R. (1999). Are Inflation and Money Growth Still Related? Economic Review,
Vol. 84, Issue Q2: 32-43.
Estrella, A., & Mishkin, F. S. (1997). Is there a role for monetary aggregates in the conduct of
monetary policy. Journal of Monetary Economics, 40(2), 279–304.
Feldstein, M. & Stock, J. H. (1994). Measuring money growth when financial markets are
changing. Journal of Monetary Economics, 37(1), 3–28.
Gali, J., & Gertler, M. (1999). Inflation dynamics: A structural econometric analysis. Journal of
Monetary Economics, 44(2): 195-222.
Gali, J., Gertler, M., & Lopez-Salido, D. (2001). European inflation dynamics. European
Economic Review, 45(7): 1237-1270.
Roffia, B., & Zaghini, A. (2007). Excess money growth and inflation dynamics. International
Finance, 10(3), 241–280.
Rudd, J., & Whelan, K. (2005). Does labor's share drive inflation? Journal of Money Credit and
Banking, 37(2): 297-312.
Rudd, J., & Whelan, K. (2007). Modeling inflation dynamics: A critical review of recent
research. Journal of Money, Credit and Banking, 39(1): 156-170.
Sbordone, A. M. (2002). Prices and unit labor cost: A new test of price stickiness. Journal of
Monetary Economics, 49(2): 265-292.
Tanner, J. E. (1993). Did monetarism die in the 1980’s?. Journal of Economics and Business,
45, Issues 3-4, 213–229.
Satoshi Nakamoto’s
forum posts and emails can be viewed at this link.
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