Money and inflation. The inflationary effects of Covid-19 crisis

Video of the presentation to the Centre for Global Finance (SOAS, University of London) on 12/5/2021, via webinar.

Summary points:

• The monetisation of enlarged budget deficits, combined with official support for emergency bank lending to cash-strained corporates, has led to extremely high growth- rates of the quantity of money (broadly defined) in leading economies, which are incompatible with price stability over the medium term. The excess in money balances by financial companies in 2020 has already led to a big bounce-back in financial markets and asset price inflation. In addition, once lockdowns are over and the pandemic is under control, the excess in money holdings by households and non-financial companies will result in higher nominal spending and output, and eventually CPI inflation.
• In sharp contrast with the aftermath of the Global Financial Crisis, the central banks’ response to Covid-19 crisis has resulted in an expansion of their balance sheets but also critically of bank deposits, and thus of the amount of money in the economy broadly defined (M3 in the USA). It is changes in the latter what explains changes in inflation over the medium term, and central banks should pay more attention in monitoring changes in broad money as effective leading indicators of inflation in 1-2 years.
• We are already seeing a significant increase in commodity prices, industrial prices and also in CPI prices in the USA. The extremely high growth rates of money seen in the USA since March 2021 (the highest rate in modern peacetime, over 25% year on year in 2020) will end up in an inflationary boom over the next few years. The duration and scale of the boom will be conditioned by the speed of broad money growth in the rest of 2021 and in early 2022; thus, on the reaction of the US Fed to rising CPI inflation in the rest of 2021 and 2022.
• The quantity theory of money provides a valid theoretical framework which relates trends in money growth to changes in inflation and nominal GDP over the medium and long term. More details on this analysis on the report by myself in collaboration with my colleague T. Congdon (IIMR) (https://iea.org.uk/publications/33536/), published in the spring 2020 by the IEA. More up to date data can be accessed at the IIMR website.

Video available below (on CFG’s YouTube channel) :

With thanks to the CGF for hosting the webinar.

Comments welcome.

Juan Castañeda

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Inflation; the next threat?

On the economic effects of the policy responses to Covid-19

Today the Institute of Economic Affairs (IEA, London) has just published a report by my colleague Tim Congdon and myself (Institute of International Monetary Research and University of Buckingham) on the debate on the expected inflationary vs. deflationary consequences of the current crisis. Of course there are many unknowns yet and we should not claim or have the illusion that we can forecast exactly inflation rates in the next 2-3 years. But what we can attempt is to do ‘pattern predictions’ (see Hayek’s 1974 Nobel lecture speech). Based on the monetary data available and the theoretical body linking changes in the amount of money to price changes over the medium/long term, we have observed in the last two months an extraordinary increase in the amount of money in most leading economies (certainly in the USA, with a rate of growth of money, M3, of 25% in April 2020). This comes from the implementation of quite significant asset purchases programmes (i.e. Quantitative Easing) and the (partial) monetisation of very much enlarged government deficits; a trend that will most likely continue for the rest of the year. It is both the extraordinary money growth rates seen recently, along with the expected persistence in monetary growth in 2020 what support our forecast of an inflationary cycle in the US (and in other leading economies, though to a lesser extent) in the next 2-3 years. The diagram below from the report says it all (see page 8).

More details in the report (IEA Covid-19 Briefing 7, June 2020) at:

https://iea.org.uk/themencode-pdf-viewer-sc/?file=/wp-content/uploads/2020/06/Inflation_the-new-threat25787FINAL.pdf. Also, the webinar presentation of the report with my colleagues Geoffrey Wood and Tim Congdon will be available soon at the IEA’s website/YouTube channel.

Juan Castañeda

Summary of the report (in pages 4-5):

• 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.

• 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. There is virtually no limit to money creation. The frequently alleged claim that ‘monetary policy is exhausted at low (if not zero) interest rates’ has no theoretical or empirical basis.

• 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 USA has reached the highest-ever levels in peacetime, suggesting that consumer inflation may move into double digits at some point in the next two or three years.

• 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, their economists ignore changes in the quantity of money. Too many of these economists 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. The quantity theory of money today provides – as it always has done – a theoretical framework which relates trends in money growth to changes in inflation and nominal GDP over the medium and long term. 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 per cent or less.

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