Deflation Play

Deflation has been in the headlines a lot lately.  Our Massachusetts based readers should understand this is not just a reference to football.  Much like Brady and Belichick, Atlas is shocked that the Patriots have allegedly been caught cheating by letting some of the air out of their game balls–again!   Of course, since underinflated balls seem to be both easier to catch and carry, the upcoming Super Bowl might be even more interesting if they are used by both teams.  We are sure Lynch and Sherman of the Seahawks would love a chance to demonstrate that on the field of play.

Football aside, deflation may not seem so scandalous.  After all, it is defined as a reduction in consumer and wholesale prices.  Why not make it easier for consumers to score the goods and services they desire?

Conventional economics contends that falling prices will grind an economy to a halt for several reasons.  First, some economist worry that consumers will begin postponing purchases because they are waiting for prices to fall further, thereby incentivizing savings at the expense of consumption.  Next, firms will defray capital expenditures until consumer demand increases.  In addition, as fewer consumers buy the goods and services provided by businesses, revenue and profitability falls.  When the topline figure drops, companies look for ways to compensate by lowering costs, and since employees are the largest expense to companies, layoff occur.  Higher unemployment means fewer taxes are collected which hurts the government’s situation.  It is tough to sell Super Bowl ads in this environment.

Since the Great Recession ended, the economic season has been tough, and every major global economy is looking for a winning advantage.  Our Federal Reserve gained yardage with a series of plays called quantitative easing (QE).  Now other central banks are following America’s game plan.  Take the European Central Bank; it just announced its very own money printing program.  Expectations are that the additional cash sloshing around in the European economy will cause demand to rise, thus combating falling inflation levels and thereby elevating the economy to the next round.

Before we declare economic victory for the home team, perhaps we should consider another nation which has been trying QE for awhile now.  Japan first started this offensive tactic in the early 2000s, and they have not made it to the end zone yet.  After a recent huddle, their central bank announced another round of similar plays last October.  While America has been the economic leader coming out of the Great Recession, even our claim to victory may be premature.  The Fed’s team, led by head coach Yellen, suggest they may stop running this aggressive offense soon.  If they do, will further deflation cause the ball to lose all of its bounce?  (by C. Cox & JR)