- The policy reaction to the Covid-19 pandemic will increase budget deficits massively in all the world’s leading countries;
- The deficits will to a significant extent be monetised, with heavy state borrowing from both national central banks and commercial banks;
- By mid- or late 2021 the pandemic should be under control, and a big bounce-back in financial markets, and in aggregate demand and output, is to be envisaged;
- The extremely high growth rates of money now being seen – often into the double digits at an annual percentage rate – will instigate an inflationary boom;
- The scale of the boom will be conditioned by the speed of money growth in the rest of 2020 and in early 2021;
- Money growth in the US has reached the highest-ever levels in peacetime. Consumer inflation may move into double digits at some point in the next two to three years, with other advanced economies following a similar trend;
- A debate on – and a test on rival economic theories – lies ahead;
- Accountability of central banks is key in democratic societies. Central banks have the power to create money out of nothing and to affect people’s livelihoods “quite significantly”.
In a new briefing paper, Dr Juan Castañeda and Professor Tim Congdon examine the inflationary effects of the economic responses to the coronavirus crisis.
In 2020 the world economy is likely to experience an output fall and increases in unemployment rates comparable to those in the Great Depression years of the early 1930s.
The policy reaction to the pandemic will increase budget deficits massively in all the world’s leading countries. The deficits will to a significant extent be monetised, with heavy state borrowing from both national central banks and commercial banks.
The monetisation of budget deficits, combined with official support for emergency bank lending to cash-strained corporates, is leading – and will continue to lead for several months – to extremely high growth rates of the quantity of money.
The crisis has shown again that, under fiat monetary systems, the state can create as much as money as it wants. The frequently alleged claim that ‘monetary policy is exhausted at low (if not zero) interest rates’ has “no theoretical or empirical basis”.
If the increase in the amount of money continues as expected, Inflation: The next threat? forecasts an inflationary boom in the US by the end of 2021 or 2022, with possible and even likely double-digit inflation rates.
Central banks seem heedless of the inflation risks inherent in monetary financing of the much-enlarged government deficits. Following the so-called ‘New Keynesian Model’ consensus, central bank economists “ignore changes in the quantity of money”.
The paper argues that too many believe that monetary policy is defined exclusively by interest rates, with a narrow focus on the central bank policy rate, long-term interest rates and the yield curve. Only when we incorporate changes in the amount of money in the analysis will we be able to assess the inflationary effects of the current policy measures in the short- to medium-term.
The only way to prevent the big resurgence in inflation implied by the report’s analysis is for the US Fed and other central banks not only to end their current stances as “ready financiers of government deficits,” but to withdraw the money stimulus (i.e. to cause the quantity of money to fall by the ‘excess over normal growth’ now being recorded). In the US, during and immediately after a presidential election year, that seems “very unlikely”.
Accountability of central banks is key in democratic societies. Central banks have the power to create money out of nothing and to affect people’s livelihoods “quite significantly”. The current monetary policy framework in most countries sets an inflation target that central banks will most likely severely exceed in the next two or three years
Dr Juan Castañeda, co-author of Inflation: The next threat?, said:
“Central banks in leading economies do not seem to be paying attention to the extraordinary rates of growth of money witnessed in recent weeks. These rates are not compatible with price stability. We will most likely see the return of ‘boom and bust cycles’ in the next two/three years.”
Professor Tim Congdon, co-author of Inflation: The next threat?, said:
“Money growth in the US over the last year has exceeded 25 per cent, higher today than at any time in previous peacetime history. Both standard economic theory and a large body of evidence argue that a big increase in inflation must follow.”
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Inflation: The next threat? is under embargo until 00.01 on Thursday 18th June 2020. An embargoed copy of the report can be found here: https://iea.org.uk/themencode-pdf-viewer-sc/?file=/wp-content/uploads/2020/06/Inflation_the-new-threat25787FINAL.pdf
Dr Juan Castañeda is Director of the Institute of International Monetary Research (IIMR). Professor Tim Congdon is Chairman of the IIMR. Both are available for further comment.