Issue of the week: Should we fear inflation or deflation?

last updated 8 January 2015

Like a shark lurking just below the water’s surface, inflation is waiting to bite us—hard, said Irwin Kellner in Marketwatch.com. “This may come as a shock,” since the most recent monthly readings of both consumer and producer price inflation show declines from the previous month. But other indicators, including the price of gold and the interest rate on inflation-protected Treasury bonds, show that many investors think “there is more inflation out there than meets the eye.” It’s already apparent in the rising prices of such common items as food, telephone and cable service, and even haircuts. Their upward spiral has been masked by declining prices for big-ticket items such as houses, cars, and computers. One spark is all that’s needed to set off an inflationary firestorm, and the banks will provide it when they stop sitting on their cash and start to lend it out again. When that happens, “inflation will be off to the races.”

That’s certainly the European Central Bank’s biggest worry, said Jack Ewing in The New York Times. As Europe struggles to overcome its debt crisis, the ECB—Europe’s counterpart to the Federal Reserve—has focused on inflation as the “one monetary dragon it considers essential to slay.” That means a policy of raising interest rates. But a growing chorus of doubters believes that deflation presents a more immediate danger. And one that’s even scarier than inflation, said Christopher Swann in Reuters.com. Although prices can sometimes fall for benevolent reasons, such as improved manufacturing efficiency, that’s not what’s happening now. Prices are dropping because of weak demand by consumers, whose debts have grown while their wages have stagnated. Unwilling to buy something today that might cost less tomorrow, they’re keeping their wallets closed. With demand down, production shrinks, and businesses lay off workers. Japan was trapped in this vicious cycle during its “lost decade” of the 1990s. Will the U.S. be next?

Sadly, yes, if the “pain caucus” in Congress and at the Federal Reserve has its way, said Paul Krugman in The New York Times. Policymakers in the U.S. and Europe, fixated on the overrated threat of inflation, have concluded that they “should stop promoting economic recovery and instead begin raising interest rates and slashing spending.” Congress has heeded these false alarms, even deciding recently to scale back aid for the long-term unemployed. But this approach runs directly counter to “the real needs of the world economy”—namely, jobs and higher incomes. Congress, it seems, would rather prove its anti-inflation bona fides than do what’s necessary to fuel a real recovery.