Inflation: The Next Threat?

Abstract

The policy reaction to the COVID-19 pandemic will increase budget deficits massively in the world’s leading countries. The deficits will largely 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 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. By mid- or late 2021, the pandemic should be under control, and a big bounce-back in aggregate demand and output is to be envisaged. The extremely high growth rates of money observed 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. Central banks seem heedless of the inflation risks inherent in monetary financing of the growing government deficits. Following the so-called "New Keynesian Model" consensus, their economists ignore changes in the quantity of money and consider monetary policy defined exclusively by interest rates, with a narrow focus on the central bank policy rate, long-term interest rates, and the yield curve. The quantity theory of money today provides a theoretical framework, which relates trends in money growth to changes in inflation and nominal GDP over the medium and long terms. A condition for the return of inflation to current target levels is that the rate of money growth is reduced back towards annual rates of increase of about 6% or less.