Monday, July 12, 2010

Inflation or Deflation

In the UK, inflation is relatively high (CPI at 3.4%. Yet, elsewhere in the world, deflation appears to be a real potential. Both the US and EU are getting close to experiencing deflation.

Inflation in US

The US is experiencing disinflation (falling inflation rate), despite pursuing quantitative easing which has led to a rapid growth of M2 measure of money supply. This graph, explains how you can increase the money supply without inflation.

Via Matthew Yglesias

Velocity of circulation is basically, the number of times money changes hand in an economy. With an economic slowdown, transactions falls. Therefore, despite a rise in the stock of money, (M * V) money supply may not rise and Output can be below potential. (see: Increasing Money Supply and MV=PY)

This has been covered before in Money Supply and Inflation in US

According to a poll by the Telegraph, a majority of economists are more worried about inflation than deflation in the UK. (link) However, with the rest of the world, being pulled into deflationary pressures, I would be more concerned about deflation. A short reminder why deflation could be very damaging to economies - Why deflation is harmful

The UK will be influenced by global inflation. With falling commodity prices, a tightening of fiscal policy, and global spare capacity, this lower inflation is likely to feed into lower UK inflation, once temporary factors have faded.


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