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    Inflation or Deflation

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    James Het
    The document discusses whether the US economy faces more risk of inflation or deflation in the coming years. It argues that neither is a significant risk in the near future due to high unemployment, low capacity utilization, and recent dollar strength reducing import costs. While large budget deficits could cause problems if not addressed, they are not necessarily inflationary on their own.

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    Inflation or Deflation

    Uploaded by

    James Het
    12 views2 pages
    The document discusses whether the US economy faces more risk of inflation or deflation in the coming years. It argues that neither is a significant risk in the near future due to high unemployment, low capacity utilization, and recent dollar strength reducing import costs. While large budget deficits could cause problems if not addressed, they are not necessarily inflationary on their own.

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    Inflatie sau deflatie

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    The document discusses whether the US economy faces more risk of inflation or deflation in the coming years. It argues that neither is a significant risk in the near future due to high unemployment, low capacity utilization, and recent dollar strength reducing import costs. While large budget deficits could cause problems if not addressed, they are not necessarily inflationary on their own.

    Copyright:

    © All Rights Reserved
    Download as PDF, TXT or read online from Scribd
    Download as pdf or txt
    12 views2 pages

    Inflation or Deflation

    Uploaded by

    James Het
    The document discusses whether the US economy faces more risk of inflation or deflation in the coming years. It argues that neither is a significant risk in the near future due to high unemployment, low capacity utilization, and recent dollar strength reducing import costs. While large budget deficits could cause problems if not addressed, they are not necessarily inflationary on their own.

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    Inflation or deflation?

    The great mystery of our macroeconomic


    future
    The investors that I talk to these days are not sure whether to worry more about future inflation in the United
    States or about future deflation. The good news is that the answer--for at least the next few years--is that
    investors should worry about "neither."
    America's high rate of unemployment and the low rates of capacity utilization imply that there is little upward
    pressure on wages and prices in the United States. And the recent rise in the value of the dollar relative to the
    euro and the British pound helps by reducing import costs.
    Those who emphasize the risk of inflation often point to America's enormous budget deficit. The
    Congressional Budget Office projects that the country's fiscal deficit will average 5 percent of GDP for the
    rest of the decade, driving government debt to 90 percent of GDP, from less than 60 percent of GDP in 2009.
    While those large fiscal deficits will be a major problem for the U.S. economy if nothing is done to bring
    them down, they need not be inflationary.
    Sustained budget deficits crowd out private investment, push up long-term real interest rates, and increase the
    burden on future taxpayers. But they do not cause inflation unless they lead to excess demand for goods and
    labor. The last time the United States faced large budget deficits, in the early 1980s, inflation declined
    sharply because of a tight monetary policy. Europe and Japan now have both large fiscal deficits and low
    inflation.
    The inflation pessimists worry that the government will actually choose a policy of faster price growth to
    reduce the real value of the government debt. But such a strategy can work only in countries where the
    duration of the government's debt is long and the interest rate on that debt is fixed. That is because an
    increase in the inflation rate causes interest rates on new debt to rise by an equal amount. The resulting higher
    interest payments add to the national debt, offsetting the erosion of the real value of the existing debt caused
    by the higher inflation.
    In the current situation, the United States cannot reduce the real value of its government debt significantly by
    indulging in a bout of inflation, because the average maturity on existing debt is very short--only about four
    years. And the projected fiscal deficits imply that the additional debt that will be issued during the next
    decade will be as large as the total stock of debt today. So raising inflation is no cure for the government's
    current debt or future deficits.
    Those who worry about deflation note that the U.S. consumer price index has not increased at all in the past
    three months. Why won't that continue and feed on itself--as it has in Japan-as consumers delay spending in
    anticipation of even lower prices in the future? And doesn't Japan's persistent deflation since the early 1990s
    also show that, once it begins, deflation cannot be reversed by a policy of easy money or fiscal deficits?
    But the recent weakness in U.S. prices is very different from the situation that prevails in Japan. Zero
    inflation for the past three months has been a one-time event driven by the fall in energy prices. The other
    broad components of the consumer price index have increased in recent months, and the consumer price
    index is up about two percentage points over the past twelve months.
    Moreover, surveys of consumer expectations show that U.S. households expect prices to rise at more than 2
    percent in both the coming year and the more distant future. That expected inflation rate is consistent with the
    difference in interest rates between ordinary U.S. government bonds and Treasury Inflation Protected
    Securities. With such expectations, consumers have no reason to put off purchases.
    A second reason for relatively low inflation in recent years has been a temporary fall in the cost of

    production. As firms shed workers during the economic downturn, output fell more slowly. The resulting rise
    in output per worker, together with slow wage growth, reduced unit labor costs. That process is now coming
    to an end as employment rises.
    So the good news is that the possibility of significant inflation or deflation during the next few years is low
    on the list of economic risks faced by the U.S. economy and by financial investors.
    But, while inflation is very likely to remain low for the next few years, I am puzzled that bond prices show
    that investors apparently expect inflation to remain low for ten years and beyond, and that they also do not
    require higher interest rates as compensation for the risk that the fiscal deficit will cause real interest rates to
    rise in the future.
    Martin Feldstein, a professor of economics at Harvard, was Chairman of President Ronald Reagan's Council
    of Economic Advisors and President of the National Bureau for Economic Research.
    Feldstein, Martin
    Full Text: COPYRIGHT 2010 International Economy Publications, Inc.
    http://www.international-economy.com
    Source Citation:
    Feldstein, Martin. "Inflation or deflation? The great mystery of our macroeconomic future." The International
    Economy 24.3 (2010): 17. Business Insights: Global. Web. 20 Oct. 2011.
    Document URL
    http://bi.galegroup.com/global/article/GALE|A248092446
    Document Number:
    GALE|A248092446

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