The quantity theory of money, the view that the money supply is the key determinant of inflation, is dead, or today’s mainstream economists tell us. The Federal Reserve is now engaged in a policy that will either put the nail in the quantity theory’s coffin or restore it to the textbooks. Sadly, if the theory is alive and wins out, the economy is in for a very rough ride.
The theory has had a long history of evidence in its support. In earlier times new gold discoveries, the source for old-fashioned money, produced inflation. Years later, in the early 1970s, Milton Friedman warned President Richard Nixon about expanding the money supply. His advice fell on deaf ears, and Nixon proceeded to pressure Arthur Burns, then chair of the Federal Reserve, to “goose” the money supply.
A horrendous decade of inflation followed as the Fed feebly applied its policy tools to avoid recession. Despite this, two recessions occurred, and the inflation rate worsened throughout the decade. It took Paul Volcker in 1980 to really slam on the money-supply brakes to get the inflation under control. Interest rates soared; the economy dropped into a serious recession, but inflation’s back was finally broken.
Anyone who believes that we are now well on the road to a global V-shaped economic recovery has not read the International Monetary Fund’s (IMF) recent gloomy World Economic Outlook. More tellingly, they clearly have not considered how very likely it is that, if the IMF’s depressing world economic outlook is realized, we will have a series of major debt crises in systemically important countries such as Italy and Brazil.
On the basis of a longer-than-expected pandemic, the IMF now forecasts that the global economy will contract by almost 5 percent in 2020. That would mark the global economy’s worst year since the 1930s Great Depression. It would also represent a much worse economic performance than that in the 2008 Great Recession.
The IMF is particularly gloomy on the United States’ and Europe’s economic outlooks. For the United States, it now expects that GDP will decline by as much as 8 percent in 2020 before rebounding by 4.5 percent in 2021. It is even gloomier on the European economic outlook. It now expects that the Euro area economies will contract by more than 10 percent in 2020 before bouncing back by some 6 percent in 2021.
The IMF correctly emphasizes that its economic forecast is subject to more than the usual degree of uncertainty. The world economic outlook would be considerably better if a vaccine or a cure for COVID-19 were soon to be developed. However, the outlook would be appreciably worse if there were to be a second wave of the pandemic or if there were to be debt-related problems associated with the economic downturn.