Probability of Inflation or Deflation

One of the most challenging issues in the modern economic environment is whether inflation or deflation will occur in the near future. This issue has become controversial and divisive among economists because of the volatile economic times. The nature of the modern economic environment has made it difficult for economists to agree on whether inflation or deflation is likely to be experienced in the future. While some economic analysts hold the view that a big increase in inflation is likely to occur in the coming years, others contend that deflation will occur. An example of the difference in opinion relating to inflation or deflation is the publications by Paul Krugman and Allan H. Meltzer. Even though the two reports were published on the same day i.e. May 3, 2009, they provide opposite views on the issue of whether inflation or deflation is likely to occur in the coming years. This paper examines whether inflation or deflation is more likely in the next two years in the current economic environment.

Inflation occurs when an economy is characterized by the existence of too much money in comparison to demand for goods and services. On the contrary, deflation occurs when an economy is characterized by the presence of too little money in comparison to the demands for products and services. Inflation and deflation have significant impacts on individuals and the economy, particularly in relation to economic growth and development. According to Amadeo (2017), inflation hurts an individual’s purchasing power since it creates an environment where people have to pay more for similar products and services. While an individual could benefit from inflation is he/she has is a beneficiary of income inflation, his/her buying power decreases if his/her income does not increase or increases at relatively slower rates in comparison to the rate of inflation.
While inflation is primarily characterized by an increase in prices, deflation is characterized by decrease in prices. Similar to inflation, deflation is a by-product of persistent change in the amount of money vis-à-vis products and services. This essentially means that inflation and deflation are basically fueled by how much money is floating in an economy in comparison to products and services. However, they are also functions of changes in productivity and/or supply and demand of goods and services. Patton (2013) defined deflation as reduction in the general price level of products and services, which in turn increases a currency’s value and encourages people and businesses to hoard their money. People and businesses hoard their money in anticipation of lower prices in the future, which creates a decline in demand for goods and services. If deflation persists for a protracted period of time, it eventually results in an economic depression.

In his publication, Meltzer (2009) stated that the United States is an inflation nation because of the actions undertaken by the Federal Reserve. He argues that inflation is likely to continue because the Federal Reserve control of the interest rate is nearly zero while bank reserves continue to increase enormously due to the Federal Reserve’s purchase of bonds and mortgages. Despite the assurances by the Fed and these financial institutions to lessen reserves significantly in order to prevent inflation, inflation is likely to remain in the coming years. This is primarily because there is no sound governmental policy and governmental plans like the stimulus program are likely to increase the government debt and do not increase productivity. Additionally, even with huge budget deficits, increased growth in the supply of money, and the likelihood of sustained currency devaluation, the United States will not experience deflation.

On the contrary, Krugman (2009) argued that the United States is likely to experience deflation in the coming years because of the increased decline in wages throughout the country. The decline in wages is fueled by the increase in wage cuts, which is an indicator of a sick economy that could even become worse. The decline in wages has been coupled with worsening job market that has forced many employees to accept wage cuts in attempts to save their jobs. However, when employers across the United States reduce wages simultaneously, workers will find it difficult to save their jobs, which will in turn generate higher unemployment rates. Therefore, the decline in wages does not benefit the economy, but worsens its problem and is likely to result in deflation in the coming years. While the government has adopted various measures to address economic challenges in the country, there are increasing risks that United States is likely to face years of deflation and stagnation.

As previously indicated, these two reports provide opposite different viewpoints on whether the United States is headed for years of inflation or deflation despite being published on the same day. The reason for the difference in viewpoints is attributable to the fact that these economic analysts used different variables as the premise for the evaluation. Meltzer (2009) examined the probability of inflation or deflation in the coming years through examining governmental policy, especially with regards to actions undertaken by the Federal Reserve. On the contrary, Krugman (2009) argued in favor of deflation in the coming years based on job market factors, particularly job creation and declining wage cuts. Generally, these economic analysts reached opposing conclusions because of the volatile economic times that have characterized the United States.

Even though the US government has undertaken various policy measures and initiatives towards improving the economy since 2009, the country is still facing some economic challenges that determine whether it will experience inflation or deflation in the near future. Apart from the United States, economic challenges have also characterized various regions and countries throughout the world. The prevalence of volatile and relatively tough economic times have resulted in the suggestion and fear that the global economy could be headed for deflation rather than inflation in the next few years. As a result, countries across the globe including the United States have been constantly reviewing their economic policies in order to address the current challenges and avoid the likelihood of deflation in the foreseeable future.

Since 2014, the Federal Reserve has embarked on aggressive initiatives that are geared towards improving the country’s economy and avoiding inflation. The Fed has been aggressive in lessening rates while pursuing quantitative easing. During the same period, US economy has experienced an increase in credit creation, growth in corporate capital expenditure (CAPEX), and tightening of the labor market (Foundational Research, 2014). Moreover, the US public sector has faced no pressure or demands to enforce new austerity. Through these economic activities, the US economy has experienced a significant turnaround as compared to 2009. As a result, the US economy is considered the most modest among the G7 countries and is expected to continue improving based on the current projections.

Additionally, the US economy is on the verge of full employment, which contributed to the Fed’s decision to increased rates in December 2016 and March 2017 and two other hikes before the end of the year (BISC, 2017). However, US inflation faced upward pressure in the aftermath of Donald Trump’s election as president and his plan for loose fiscal policy. Despite the upward pressure on inflation, the response by the Federal Reserve has helped to stabilize and improve economic recovery. In essence, Federal Reserve’s policies and initiatives have played a crucial role in lessening inflation expectations and avoiding a possible deflation in the foreseeable future.

In light of these factors, I think that inflation is more likely in the United States in the next two years in the current economic environment. As compared to 2009, the US is far from facing deflation due to improved economic conditions that have been brought by the Federal Reserve. Based on inflation prediction markets, the rate of inflation in the United States will be lower than the Fed’s 2% target instead of above it in the next two to three years (Wolfers, 2015). According to a study by Foundational Research (2014), the major economic blocks across the globe will either undergo decline in prices or tremendously low inflation in the near future.

The United States will not experience deflation in the next two years because of the expected strengthening of the dollar. The strengthening of the dollar implies that the country will find it difficult to generate any form of sustained increase in inflation rates. My view of inflation rather than deflation in the next two years is also supported by the fact that the US economy has historically done well during periods of mild deflation. When US economy has faced mild deflationary periods like in 2008-2009, it has performed well through suitable fiscal policies and the Fed’s initiative and has successfully avoided deflation. As a result, in the current economic environment and recent policy changes and initiatives, the US economy is headed for inflation in the next two years, but at extremely low rates.

In conclusion, inflation and deflation are two functions of changes in productivity and/or supply and demand of products and services. Economic analysts tend to differ in their views on whether an economy is headed for inflation or deflation due to the volatile nature of today’s economic environment. Moreover, the differences in viewpoints are attributable to the use of different variables as the premise for evaluation. Over the last few years, the US government through the Federal Reserve has embarked on several initiatives to enhance the economy. These initiatives have played a crucial role in the country’s economic recovery from the 2008-2009 depression. Since the US economy has significantly improved, I believe that it will experience inflation rather than deflation in the next two years and in the foreseeable future.





References
Amadeo, K. (2017, June 21). How Does Inflation Impact My Life? Impact on You and the Economy. Retrieved October 10, 2017, from https://www.thebalance.com/inflation-impact-on-economy-3306102
BISC. (2017, April 23). The Fed and the Balance Sheet: Shrinking the Giant. Retrieved October 10, 2017, from http://www.bsic.it/fed-balance-sheet-shrinking-giant/
Foundational Research. (2014, November 27). Inflation or Deflation: What is Next for the United States? Retrieved October 10, 2017, from https://seekingalpha.com/article/2715525-inflation-or-deflation-what-is-next-for-the-united-states?page=2
Krugman, P. (2009, May 3). Falling Wage Syndrome. The New York Times. Retrieved October 10, 2017, from http://www.nytimes.com/2009/05/04/opinion/04krugman.html?_r=1
Meltzer, A.H. (2009, May 3). Inflation Nation. The New York Times. Retrieved October 10, 2017, from http://www.nytimes.com/2009/05/04/opinion/04meltzer.html
Patton, M. (2013, July 1). Inflation or Deflation: Which is the Greatest Risk? Forbes. Retrieved October 10, 2017, from https://www.forbes.com/sites/mikepatton/2013/07/01/the-truth-behind-the-feds-monetary-expansion/#6f36ad897236
Wolfers, J. (2015, March 6). A Prediction Market for Inflation, or Deflation. The New York Times. Retrieved October 10, 2017, from https://www.nytimes.com/2015/03/08/upshot/derivatives-market-shows-a-rising-fear-of-deflation.html