The coronavirus pandemic has not only come as a profound shock to the major economies, but also exposed tensions between leading schools of thought. Uncertainty has arisen about the medium- and long-term consequences of the policy responses to COVID-19. Will the pandemic, and the consequent major upheaval in economic policy, lead to deflation or more inflation? This article—which is intended above all as a contribution to the emerging deflation vs. inflation debate—begins by discussing official policy in recent months. It then states a position in the tradition of the quantity theory of money and develops the argument that inflation will rise significantly in the aftermath of the pandemic.

This paper considers the basis of the thesis of left-wing economist Thomas Piketty, the author of Capital in the Twenty-First Century, that “a market economy based on private property” has “powerful forces of divergence” which are likely to increase future inequality. Although Picketty’s “fundamental contribution” has been lauded as a contribution in the field of data collection and presentation, Piketty’s book contains a number of “explanatory narratives”, with descriptions of events and the identification of possible causes. This paper considers its treatment of one such narrative, that rising inequality was a principal cause of the Great Recession of 2008 – 2010. An analysis of data on the US economy in the Great Recession shows that the behaviour of the corporate sector, unrelated to personal income inequality, was responsible for about half of the drop in demand. In contrast, the personal sector, where inequality could matter, experienced falls in residential investment and in personal consumer expenditure, but a long run investigation found no relation between the degree of inequality and the stability of the housing market. Finally, an econometric analysis of the effects of personal disposable income and debt on consumption, two variables highlighted by Picketty, showed them to have had close to no impact on the recorded change in consumption.

Two ways of thinking about the causation of the Great Recession are contrasted: the ‘mainstream approach’ and the ‘monetary interpretation’. According to the mainstream approach, the Great Recession was due to the potential insolvency of the banking system and the correct antidote was tighter regulation. The paper proposes an alternative ‘monetary interpretation’, arguing that the macroeconomic trajectory of the major G7 economies in the Great Recession is readily understood by means of the monetary theory of the determination of national income. The main cause of the Great Recession is seen as a collapse in the annual growth rate of broad money from double-digit annual rates in the years before mid-2008 to virtually zero in the following three years. Further, the dominant reason for the money growth collapse was the abrupt and comprehensive tightening of bank regulation in late 2008. In particular, the raising of regulatory capital/asset ratios was a shock that intensified the downturn.

The main conclusion of the paper is that – even if bank lending to the private sector is falling (and destroying money balances) at a zero short-term interest rate – the monetary authorities can always increase the quantity of money (broadly defined to include all bank deposits) without limit by means of debt market operations. Such operations are to be distinguished from more conventional money market operations. Assuming – in line with standard theory – that equilibrium nominal national income increases by the same percentage as the quantity of money, debt market operations are available at all times to pre-empt a downward debt-deflationary spiral.

The paper differentiates debt market operations from money market operations, and a broad liquidity trap (in which increases in the quantity of money, broadly defined, do not reduce the long bond yield because of the infinite elasticity of non-banks’ demand to hold money) from a narrow liquidity trap (in which increases in the monetary base do not boost the quantity of money, because banks behave as if their demand for base were infinitely elastic). Keynes analysed the broad liquidity trap in The General Theory.

Two alternative concepts of the output gap, Keynesian and monetarist, can be distinguished. When they use the phrase, economists should make clear which concept is under discussion. The first concept, developed by Okun in the early 1960s, defines the output gap relative to a full employment notion of output. It was a standard part of the Keynesian policy toolkit in the 1960s and 1970s, and was associated with the active use of fiscal policy to promote full employment. As stated by Okun, the gap takes only positive values and these values rise with unemployment. The second concept, which is derived from Friedman’s 1967 accelerationist hypothesis, defines the output gap relative to the natural-rate-of-unemployment level of output. It takes both positive and negative values, and, following the lead of the international research organizations (the OECD and the IMF), an above-trend level of output is said to define a ‘positive output gap’ and a beneath-trend level a ‘negative output gap’.

Tim Congdon responds to the article by Thomas Mayer and Patrick Minford, ‘Monetarism: A Retrospective’ that appeared in World Economics, Vol. 5, No. 2 (April–June), 2004, pp. 147–185.

The UK achieved a remarkable degree of macro-economic stability in the 1990s. Contrary to expectations when the pound was expelled from the European exchange rate mechanism in September 1992, over the next ten years inflation was kept almost exactly on target and its volatility declined by over 90 per cent compared with the previous 20 years. Stability was achieved when the official aim was to balance the budget and major industries were being de-nationalised, contradicting claims that Keynesian policies are needed.

The newly-formed European currency will compete with the dollar to become the world’s leading currency in the 21st century. Its prospects in this competition will depend partly on the size of the European economy compared with the US economy. This article argues that unprecedented demographic trends will reduce employment and curb output growth in Europe, and so cause the European economy to lose ground relative to the USA. The demographic problems are more serious in Germany and Italy, where a falling population of working age may lead to declining employment and stagnating output over periods of 20 or 30 years. Against this background the euro will fail to supplant the dollar as the world’s leading currency.