Low inflation in the Great United States

from Washington Post

There are times when it seems we’re worrying about things that aren’t worth worrying about. A good example these days is inflation. Amazingly, the complaint is that it’s not rising fast enough. In March, the consumer price index, or CPI, had increased 1.9% over the past year. The gain of another inflation indicator, the “deflator” of the personal consumption expenditures, or PCE, was 1.5%.



As inflation leads to lowering purchasing power, people (especially those who don’t study economics :D) sometimes think that deflation is beneficial. As a matter of fact, deflation does has some, but very limited advantages to the economy. Opposite to inflation, deflation has the effect of reducing income gap. Also, some cash holders believe that they are temporarily better off in the short term as the real value of money increase.

Contrary to people’s belief, deflation is known to have many negative consequences for an economy. As price level falls, consumers and firms delay their purchase because they expect prices to fall further, and this results in a deflationary spiral in which price level falls leads to fall in AD, which leads to price level to fall further. This results in a deepening recession and high cyclical unemployment that both means government policies are required to be implemented. But in such cases, government usually do not have sufficient money too to carry out policies as they don’t receive much tax revenue in situations of recession and high unemployment. More importantly, bankruptcies can be caused by deflation. As real value of debt increases, borrowers find it difficult to repay their loans. Bank or large money loaners will suffer the most, and their bankruptcies could lead to financial crisis of the economy in which they existed in. This is similar to what happened to U.S. during global financial crisis. Following the bankruptcies of several wolf street firms, the economy found itself almost impossible to revive from the recession, and it took a remarkable long time to do so.

Now, even though not as bad as the global financial crisis in 2018, the U.S., as describes in the article, experiences a low inflation that is believed to harm its economy. Accompanied by the low inflation is the decreasing economic growth, or generally an “economic depression”.

Typically, the Fed cuts interest rates to reverse an economic downturn. But interest rates, reflecting inflation, are already low. The fear is that the Fed won’t be able to cut rates enough to prevent a recession from getting worse.

Consider. The so-called fed funds rate — the rate on overnight loans and the rate most influenced by the Fed — is now set at about 2.5%. By contrast, it was 5.25% in 2007, the start of the last recession, and higher earlier. If the Fed can only cut rates modestly before they hit zero, then the next recession could be lengthy and stubborn. That’s the argument.

According to the article, what’s even worse in this case is that the Federal Government of United States seems to lack the ability to alleviate the country out from economic depression. Though expansionary fiscal policies can be used to decrease tax rate and increase funds rate to increase economic activities through the Keynesian multiplier, the Fed did not do so. Also, the Fed is not able to implement expansionary monetary policies that decreases interest rates to boost economic activities, since interest rates are already very low. The combination of these factors raises economists’ and domestic citizens’ concerns.

Derrick Ng

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