Tuesday, July 20, 2010

Inflation or deflation

The Economist asks a simple question (and given that I had made a portfolio reallocation decision based on my answer - and perhaps a wrong answer at that) I was interested in seeing what the participants of the forum had to say.

1. Ricardo Caballoro, MIT: On average (across the world), inflation is not and will not be a concern for quite a while.
2. Arminio Fraga, Gavea Investimentos: In the near term, the excess capacity found in most advanced economies pushes prices down. But central banks know how to pump up aggregate demand and fix this, it is just a matter of time. So deflation is not a lasting threat.
3. Stephen Roach, Morgan Stanley: ... as I look out over the next five years, I see a good case for both another whiff of deflation only to be followed by an outbreak of accelerating inflation. The sequencing is key. I worry that fears of deflation will lead to yet another spate of policy blunders that could ultimately set the stage for meaningful deterioration on the inflation front.
4. Gilles St. Paul, CEPR: As long as the recession continues, the risk of inflation is small. However, the scenario of a return to high inflation as we exit the crisis should not be dismissed, for a number of reasons.
5. Adam Posen, IIE: Most macroeconomists instinctively believe that deflation is bad, and we certainly can generate a list of reasons why that should be so.
6. Stephen King, HSBC: The Western world is in danger of following in Japan’s deflationary footsteps.
7. Scott Sumner, Brandeis: I believe that the US and Europe are unlikely to experience outright deflation in the foreseeable future.
8. John Makin, Caxton Associates: Deflation is currently a greater threat to the world economy than inflation.
9. Tom Gallagher, ISI: ... neither inflation nor deflation is the base case, the arguments against inflation are stronger, so I worry more about deflation.

Some answers were more straightforward than others. (I excluded Brad DeLong only because his response wasn't easy to excerpt but he definitely falls in the deflation camp.) Except for Stephen Roach, no one really gave a time frame (Roach says 5 years). And some economists tend to couch their responses with more caveats than others - perhaps this is an inate ability of economists to cover our asses.

Here is Jim Hamilton (which sounds extremely crisp and clear to my ears):

For the last year and a half my assessment has been that the near-term pressures on the U.S. economy were deflationary, while long-term fundamentals involve significant inflation risks. It's time for a look at the data that have come in over the last 6 months, and time to say that I still see things exactly the same way.

... I often hear the idea expressed that all the money that the Federal Reserve has created through its various responses to to the financial crisis has to produce inflation. With the exception of the assets the Fed acquired through the
AIG deal, which aren't going anywhere, most of the other special facilities the Fed implemented in the fall of 2008 have been wound down, replaced with long-term holdings of mortgage-backed securities and agency debt.

... The source of my concern about long-run inflation comes not from the expansion of the Fed's balance sheet, but instead from worries about the ability of the U.S. government to fund its fiscal expenditures and debt-servicing obligations as we get another 5 or 10 years down the current path. Just as many analysts have had trouble seeing how Greece can reasonably be expected over the near term to move to primary surpluses sufficient to meet its growing debt servicing costs, I have similar problems squaring the numbers for the U.S. looking a little farther ahead.

... I am definitely not among those calling for current budget cuts-- that would only aggravate our immediate employment challenges. But I do think now would be an excellent time for fiscal reforms that make the long-run math look substantially more responsible. Examples include raising the eligibiity age for Social Security and Medicare, increasing the Medicare copay, budget reform to bring earmarks under control, a plan to ease the government out of responsibiity for implicitly or explicitly guaranteeing U.S. mortgage debt, and reforms at the state and local government level to bring their long-run pension liabilities under control.

Menzie Chinn Follows up with some more graphs (and he is also in the deflation camp). Subsequently, Jim Hamilton lists some ideas as to how to fight deflation.

And from Mark Thoma, the Feds may have a schizophrenic view perhaps due to salty and fresh economists:
Atlanta Fed:
Since last October, the consumer price index (CPI) has gone up an annualized 0.7 percent. On an ex-food and energy basis, the number is a little lower, at 0.5 percent. And the Cleveland Fed's trimmed-mean and median CPIs, at 0.7 percent and 0.2 percent, respectively, also put the recent trend in consumer prices in pretty low territory.

While the Richmond Fed:
The recent spate of weaker economic data doesn’t mean the U.S. recovery is faltering, and the Federal Reserve continues to get closer to the time when it will need to raise interest rates... Lacker believes, like many other Fed officials, that the economy doesn’t yet need fresh support from the Fed.

which drew the following comment from Mark Thoma:
What's he afraid of? Inflation?

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