Lockdown measures will cut output in the current year by between 5 and 10 per cent, perhaps more, in the main developed countries and many developing ones. Indeed, 2020 may be — in output terms — the worst for the world economy since the Great Depression of the early 1930s. That much is uncontroversial. But a big debate is brewing among economists about whether the prospect over the next few years is for a rise in inflation, or a fall (disinflation), or even an outright fall in the price level (deflation).

Roughly speaking, those economists who believe in a monetary approach to price level movements — based ultimately on the quantity theory of money (or “monetarism”) — expect a rise in inflation. The alternative is more pragmatic, and also more widely-held. Its supporters tend to emphasise cost pressures arising in labour and commodity markets, and they sometimes call themselves “Keynesian” or “New Keynesian”.

They are on the disinflationary or deflationary side of the exchange. The debate is therefore to some extent another iteration of the never-ending quarrel between Keynesianism and monetarism about how much money and banking matter to macroeconomic outcomes. The argument here will be that the quantity theorists will prove right, and that 2021 and probably 2022 will see a nasty outbreak of inflation in most countries.

On the face of it, the pragmatists are talking sense. The lockdown has been a calamity for the travel and holiday sectors, with vicious repercussions on the demand for oil. The price of oil, as measured by the Brent contract, has tumbled from over $60 a barrel at the start of the year to $26 a barrel at the time of writing. As oil is the most important single commodity in modern economies, its over-supply signals an early fall in industry’s costs and a welcome saving for consumers. The oil price slump seems to tilt the debate strongly towards the disinflation and deflation points of view.

Moreover, the lockdown has led to bankruptcies and job closures. The jump in unemployment — like the onset of the epidemic — has been sudden, unexpected and a severe shock to confidence. In the United States, for example, the unemployment rate has shot up from under 4 per cent for most of 2019 to 12.4 per cent in mid-April this year and is forecast to climb towards 20 per cent in coming weeks. The speed of the rise — which has brought misery to more than 20 million workers — is faster and more dramatic than in the Great Depression. A severe excess supply of labour seems to have emerged, which should curb pay increases and dampen wider inflationary pressures. Again, the evidence appears to favour the disinflation and deflation positions.

The disinflation/deflation school focuses on the short run, and appeals to the straightforward and obviously correct notion that revenues must exceed costs if companies are to have an incentive to produce. For those who have to take decisions in the so-called “real world”, including top policymakers, the analysis is often persuasive. To oppose these conclusions by appealing to trends in the growth of the quantity of money tends to lose the attention of movers and shakers in finance ministries and central banks.

It has to be admitted that the relationship between the quantity of money and the price level can seem complex and arcane, and that the theory behind it is readily dismissed as remote from business reality and too academic. Nevertheless, the pragmatists’ approach is unsatisfactory in fundamental ways. Most obviously, it is useless in explaining why inflation rates vary between countries over space and between periods over time.

The scale of the US’s fiscal largesse has never been seen before in peacetime

All nations involved in international trade face the same prices for raw materials, including oil, but the historical record shows that this similarity in cost conditions has not precluded vast divergences in price level changes in different countries. The price of imported oil is the same in Japan and Switzerland as in Venezuela and Zimbabwe, but the first two countries have virtual price stability whereas the latter suffer from hyperinflation.

Moreover, labour market indicators can be very misleading. On average unemployment has been much lower in Britain in the last 25 years than it was in the 1970s and 1980s, which — according to New Keynesian thinking — ought to have put more upward pressure on prices and inflation. In fact, inflation has also been much lower in the last 25 years than in the previous two decades. The millennial generation may have much to complain about, but for them — unlike their baby boomer parents — double-digit inflation and sky-high interest rates are virtually unimaginable. (Note that this does not mean that double-digit inflation and sky-high interest rates have become impossible.)

Even the recent surges in unemployment may not foreshadow falling wages and prices. Comparisons have often been made in the last few weeks between trying to control the coronavirus and fighting a war. These comparisons may have been artificial and exaggerated, but in one respect they are right. At the end of both world wars demobilisation, with huge numbers of soldiers returning to civilian life, had an impact on the labour market similar to that of coronavirus-related spate of job losses.

After the Second World War nine million military personnel left the US armed forces, a figure similar — as a proportion of the working-age population — to the recent 20 million rise in unemployment noticed above. But that did not prevent the annual increase in consumer prices moving up from just over 2 per cent in mid-1945 to more than 20 per cent in early 1947.

A cost-based analysis of inflation may be plausible to many central bank officials, whereas the monetary story does not convince them. But that is their problem. The message of long runs of data is clear: that all large movements in nominal national income and the price level have been associated with — and usually preceded by — similarly large increases in the quantity of money. It is therefore essential to check what is happening to the growth of the quantity of money in the main countries. The emphasis here is on the US, where the departure from the old-time religion of balanced budgets and sound money has been extraordinary.

At no point in his administration has President Trump shown much interest in restoring a balanced budget. In December 2017, less than a year into office, his Tax Cuts and Jobs Act was passed. It was widely understood that one result would be an increase in the budget deficit, which duly went up from $666 billion in 2017 to $780 billion in 2018 and $984 billion in 2019. These were all high and rather worrying figures, particularly as they coincided with peacetime and prosperity, which normally help tax revenues and limit welfare expenditure. The stable macroeconomic context ought to have been accompanied by deficits at minimal levels or surpluses.

Last year the US government had trouble finding long-term investors in the capital markets to buy all of its newly-issued debt. It borrowed almost $350 billion from US commercial banks and $80 billion from the Federal Reserve, the central bank. Although these numbers were not vastly out of line with previous experience, government borrowing from the banking system — which creates new money balances — was higher than for many years. The annual increase in the quantity of money was about 4 per cent for most of the 2010s, as was the annual increase in nominal gross domestic product.

But at the end of 2019 money growth had edged up to more than 8 per cent. (Here and throughout this article the phrase “the quantity of money” means the M3 measure, for which estimates are prepared by the consultancy Shadow Government Statistics. It includes all time deposits, and corresponds to the concept of money favoured by Milton Friedman and Anna Schwartz in their epochal 1963 study, A Monetary History of the United States 1867-1960.)

Before the coronavirus epidemic became a pressing concern in March, the administration envisaged some further financial slippage in 2020, with its projections showing a federal deficit of more than $1,000 billion. But the big upheaval in public finances has been since Trump announced a national emergency on 13 March. The scale of the fiscal largesse is unprecedented in peacetime, and staggering as regards both the amounts of expenditure and the range of interest groups that are being bribed.

The lockdown has stopped people from working, which has inevitably lowered forecasts of tax revenue. Further, to mitigate the loss of income facing US citizens, the administration has handed out so-called “stimulus cheques” to every household, at a rate of $1,200 per adult and $500 for every dependent child. The fiscal cost of these handouts has been put at about $300 billion.

In addition, the US Treasury has indemnified the Federal Reserve and US commercial banks in a variety of loan schemes, so that the banks will have only small losses if the loans are not repaid. Separately, $50 billion of rescue funds have been set aside for the airline industry, with 70 per cent of this sum being grants that the companies need never pay back. The cost of the whole caboodle — of all the handouts, revenue shortfalls, extra subsidies, grants, guarantees, indemnities and the rest — is widely forecast to take the federal deficit towards $4,000 billion, when it will be more than 15 per cent of national output and four times the size of its immediate predecessor.

We have just shown that in 2019 — when that predecessor deficit was just under $1,000 billion — financing from outside the banking system was little more than half the total. Suppose that such responsible non-monetary financing doubles in 2020, to about $1,000 billion. $3,000 billion or so would then have to be covered from the banks, a figure equal to about 15 per cent of the quantity of money at the end of 2019.

This would be pure “monetary financing of the budget deficit”, along lines that have often been accompanied in Latin America by rapid inflation. Most US economists are complacent, some apparently believing that the laws of monetary economics apply in the southern hemisphere but not in the northern. There are even surprisingly many apostles of a body of radical spendthrift ideas called “Modern Monetary Theory”.

According to cruder versions of MMT, inflation cannot result from monetary financing of the budget deficit, because the state’s right to issue legal tender enables it to extract resources from society and hence amounts to a “magic money tree”. (The finance ministers of Venezuela and Zimbabwe may chuckle at this.)

But the $4,000 billion budget deficit and the possibility of $3,000 billion of monetary financing are not the end of the US’s current fiscal and monetary splash. The leap in unemployment and the talk of deflation has led some analysts to see the falls in output as being caused by a lack of aggregate demand. They believe that the correct response is therefore to boost the economy by the same kind of measures as in late 2008 and 2009. The Federal Reserve has embarked on a potentially unlimited round of “quantitative easing”, with purchases of government and asset-backed bonds running into the hundreds of billions — perhaps even into the low trillions — of dollars.

Nowadays bank deposits are the main form of money. Over the last decade the typical annual growth of deposits at US commercial banks — like that of broad money as a whole — has been 4 per cent. Such as been the lurch towards liberality and expansionism by the Fed and the administration that in the eight weeks to 22 April bank deposits climbed by 11.5 per cent. If that pace of growth were to continue for a year, they would more than double in size. Yes, the US would experience a money growth rate of 100 per cent.

As the chart above shows, recent developments constitute an astonishing break from the stable money growth pattern of the last decade. (The chart relates to the three-month annualised rate of increase in the quantity of money, and ends with the final value including an estimate for May 2020.)

Everyone understands that the administration had to respond vigorously to the Covid-19 threat, and that the Federal Reserve had to show itself able and willing in its support of the administration. No doubt the money growth numbers for March and April are exceptional, and more moderate growth will soon be reported. All the same, it is likely that late 2020 and early 2021 will see the highest one-year growth rates of the quantity of money in modern US peacetime history.

Policy-making elsewhere in the other advanced countries has been less extreme, although similar in character. The “inflation vs. deflation” debate is still open and fascinating. But — if in the US the quantity of money keeps on growing by more than 1 per cent a week — the world’s largest economy is likely to suffer double-digit annual inflation and sky-high interest rates at some point in the next few years.