- Paul Krugman writes convincingly on the dangers of deflation threatening the US economy. (article)
- On the same day, Alan Meltzer argues the Fed is ignoring the risk of Inflation. (article)
Paul Krugman points to the large spare capacity, debt deleveraging and falling nominal wages as powerful causes of deflation. He also makes the point that deflation and falling wages will be very harmful for a struggling economy. A cut in nominal wages is akin to rising interest rates on mortgage payments.
Alan Meltzer looks to other features of the economy. He sees
- large government borrowing
- Quantitative easing and growth of money supply.
- and a Fed seemingly ignoring risk of future inflation.
So which risk is greater?
I still feel it is the threat of deflation that poses the gravest risk to the economy. The scale of monetary and fiscal stimulus means it may be hard to overshoot the inflation target. But, overshooting an inflation target will be much less painful than a decade of economic stagnation.
And this is a lesson the ECB may need to learn pretty quick.(update, ECB yesterday cut rates to 1% and even made tentative moves towards quantitative easing) But, the ECB still lag behind US and UK in dealing with the threat posed by deflation.