Many major economies, namely the United States and Europe, are now in a period of falling inflation. The danger of slipping into deflation is now the more likely threat.

Central banks need a new plan for 2014

John H. Makin

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Central banks would do well to begin
talking about what they would do if the global economy
became weaker than expected instead of only talking
about how they would withdraw stimulus if the economy

gets stronger

Opponents of quantitative easing (asset buying) have often warned of the inflationary threat brought about by central banks’ aggressive asset-buying programs. However, many major economies, namely the United States and Europe, are now in a period of falling inflation (disinflation). The danger of slipping into deflation (negative inflation) is now the more likely threat. The eurozone is leading the trend, with its year-over-year inflation rate having fallen from 1.1 percent in September to 0.7 percent in October. Deflation would harm investment, spending, lending, and employment, which would collectively weaken an already tepid global economic recovery. The European Central Bank and Fed must strike a balance between continuing quantitative easing (risking an asset bubble) and tightening monetary policy (risking deflation).

Key points in this Outlook:

• Fear of quantitative easing–generated inflation has veiled the actual trend of falling inflation (disinflation) in the United States and Europe.
• Europe is leading the disinflation trend, which could reduce investment, spending, lending, and employment in the eurozone.
• Europe’s accelerating movement from disinflation to negative inflation should encourage the Fed to prioritize its role of ensuring price stability.

“Everyone has a plan until they get punched in the mouth.” — Mike Tyson

Central banks have a plan: stay easy until the economy recovers and watch out for inflation. In short, get ready to tighten. Maybe in view of an alarming global drift toward deflation (a falling price level of goods and services), tepid growth, and stubbornly high unemployment, they should think about a different plan: get ready to ease more.[1]

The European Central Bank (ECB), Fed, and their silly, hyperbolic critics have been so busy worrying about asset bubbles (hyperinflation) and how to exit aggressive programs of asset buying (“tapering” in the US jargon) that they have failed to notice a steady drift toward outright deflation.

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