The “bits” are the components of the equation of Exchange in growth form:
M is the growth rate of money supply, V the growth of velocity (the inverse of money demand), and P+Y the growth of aggregate nominal spending, or NGDP growth.
However, when you look at the V “bit”, you see that velocity growth crashed
In fact, money supply growth has fallen short of money demand growth. That becomes clear when you put those two pieces together and add the NGDP growth “piece”.
Notice that before the Covid19 shock, money supply growth adequately offset velocity changes to keep NGDP growing at a stable rate close to 4%.
When the pandemic hit, velocity tanked while money supply growth lagged behind. More recently, money supply growth has been sufficient, given velocity, to keep NGDP moving at sub-zero temperatures.
Hard to imagine that “heat” (inflation) can be generated by a “thermostat” dialed-down to such low temperatures!
Now for the “pieces”. Those refer to the labor market, more specifically to the construction of the unemployment rate. Two “pieces” stand out. The chart shows that data for workers on temporary layoff and for those marginally attached were distorted by the pandemic.
Last June, Jed Kolko devised a “core rate of unemployment” that considers those two anomalies. From the unemployment level he subtracts workers on temporary layoff and adds marginally attached workers (those not in the labor force but prepared to work). The adding permits to count as unemployed those workers that were not able to get their job back after being laid-off.
The chart shows that until the pandemic hit, headline and core unemployment were closely attached, so the core rate now gives us a less misleading view of the unemployment rate.
A zoom of the picture indicates that the discrepancy between the headline and core rates are closing, so shortly we may go back to looking just at the conventional (headline) data.
We can play around with the “bits & pieces”. The next chart shows that the drop in aggregate spending (NGDP) growth in 2020 was much steeper & deeper than what happened in 2008/09. Nevertheless, core unemployment rose much less now than in 2008/09.
Note that in both instances, unemployment stops rising when NGDP growth reverses direction. The question remains, however, about why the huge difference in the behavior of unemployment.
One reason might be the suddenness of the drop in spending. While it took only 4 months for spending to fall from peak to trough, in 2008/09 it took 21 months. Real variables like employment take time to adjust. That still doesn´t explain why unemployment didn´t keep rising even after spending reversed direction.
What guides unemployment is not just the behavior of nominal spending but, more importantly, the ratio of wages to nominal spending (NGDP). The next chart indicates that the rise in the ratio of wages (average hourly earnings) to NGDP jumped from trough to peak in just 2 months and then dropped rapidly, even while NGDP growth was still falling. The 2008/09 story is very different.
The explanation for the (surprising) observation of a relatively small rise in unemployment in spite of a large fall in spending is evident in the next chart, which shows that wages fell in absolute terms, leading to the quick reversal in the wage/NGDP ratio and thus containing the rise in unemployment. In 2008/09, wages rose continuously.
To wrap up, the next picture shows the “end result” of the “bits” (the outcome of monetary policy trying to adequately offset changes in velocity, but failing at present) which helps define the “shape of the pieces” (core unemployment & payroll employment in this case).
Where we observe that faltering monetary policy leads to unemployment not falling and employment being constrained.