While most economists do not expect the U.S. economy to descend into deflation, some believe it is certainly possible. And, at least in the near term, they are more concerned about deflation than excessive inflation.
Only last year, concerns about price stability were focused on greater-than-desired inflation because of the Federal Reserve’s massive balance sheet. But back then, the economic recovery was progressing quite well. Moreover, that was also before China started tightening and Europe began suffering sovereign debt problems.
Now, as the U.S. and global economic recovery appears to have stalled, inflation has slowed down. In fact, St. Louis Fed President James Bullard authored a paper discussing “the possibility that the U.S. economy may become enmeshed in a Japanese-style, deflationary outcome within the next several years.”
Most recently, the FOMC acknowledged that “pace of recovery in output and employment has slowed in recent months” and going forward, it will probably be “more modest in the near term than had been anticipated.”
Richard DeKaser, chief economist of Woodley Park Research, said that deflation is possible if the recent slump turns into a more persistent weakness (however, he is predicting that the economy will recover), resulting in significant slack in the economy. A ‘slack’ essentially means that there are idle resources and spare capacity chasing not enough demand, which leads to lower prices (deflation).
The strength of the jobs market is also important to consumer deflation because wages may come under pressure (or at least not rise) if the supply of labor significantly exceeds the demand for labor.
DeKaser added that if wages ever fall, then consumers may struggle under debt (which remains constant), leading many of them to sell their assets, which leads to lower asset prices and potentially a deflationary cycle.
Michael Cosgrove, principal of the Econoclast in Dallas, said that there is a “one out of four or five” chance that the U.S. economy will morph into a Japan-styled deflationary situation.
He believes that like Japan, the U.S. suffered a collapse in equity and real estate prices and is following that collapse with “failed Keynesian fiscal policies [like the health care and financial reforms], massive increases in outstanding central government debt and higher taxes.”
Cosgrove is particularly concerned that government policies – namely higher taxes, increased health care costs for employers, and the impact of financial reform on the availability of credit – that may choke off growth and employment and lead to deflation.
However, compared to Japan, the U.S. is much more aggressive in its quantitative easing, which decreases the chances of prolonged deflation, added Cosgrove.
By Hao Li – ibtimes.com
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