Saturday, October 4, 2008

What is More Likely - Inflation or Deflation?

Readers Question: What is More Likely - Inflation or Deflation? This seems paradoxical as inflation is the opposite of deflation - why might we be concerned with both at the present time?

Is Deflation a possibility?

Deflation is a fall in the general price level. It is quite rare amongst Western Economies. The last serious period of deflation was during the Great Depression of the 1930s (though Japan experienced deflation during 90s and 00s).

Deflation usually occurs because of a serious economic slowdown. If the present slowdown in economic growth turned into a major recession, deflation could become a real possibility. Deflation could occur because of:
  • Falling house prices reducing spending
  • Falling value of shares
  • Contraction in investment caused by banks being unwilling or unable to lend.
  • Falling economic growth causing firms to try cut prices and possibly wages.
Deflation is generally considered to be very harmful for the economy as it exacerbates any recession through discouraging further spending (During periods of deflation people delay purchases because they think they will be cheaper in the future.)

However, at the moment, deflation is unlikely. We have cost push inflation and economic activity would need a very large decline before deflation becomes likely.

Could US experience Hyperinflation?

Again this is very unlikely. Although inflation is currently high, this is likely to drop in the coming months due to falling oil prices and a slowing economy.

Hyperinflation could only be a problem if National debt got out of control and the government started to print money. I examined the likelyhood of this occuring in - US Dollar Collapse?


Econ. José Manuel MARTIN said...

Of course one of the causes that may rise inflation is the print of money by the government. But the main reason is that the money supply must match the demand, sometimes with printed money, sometimes with too much credit. So, when the value of money is low, there is your inflation. US economy might have that kind of problem, if the government imputs too much money than is needed or wanted. How could anyone know that for sure? That's a tough oine. I believe that the first thing we have to do, is to separate the monetary problem from the financial one, sometimes it's posible, and I believe it is to time do it so.

Anonymous said...

CPI fell in August, which is the start of deflation. Credit is tight, most of america owns more then their house is worth. Those that want loans may not get them. Those that want to buy will wait as long as possible because they know prices will continue to drop (deflation anyone), and as unemployment rises spending power decreases. Ummmm to me this is the downward deflationary spiral. Japan in the 90's. The more I see it, it would take the printing presses running for a while to create inflation. Remember unemployment lags and will increase. People are selling out of the market, less $ for companies, employees. Not good, need stimulus on the ground level as well, other wise the big bank write offs will continue until everyone that bought a house in the last 5years has lost it. Need 80's style inflation, have no choice at this point. Sure there will be a time that inflation will hurt as well, but I see deflation as the worse evil.