Economists: Deflation is a Bigger Threat Than Inflation

Tuesday, 10 Jan 2012 07:55 AM

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Talk that inflation is on the rise continues to grab headlines but deflation, a more damaging economic cycle than rising prices, is becoming more threatening — and more likely, economists say.

Americans more than ever are looking for lower prices, as evidenced by the rise of deal sites such as LivingSocial and Groupon as well as by strong earnings at low-cost retailers like Walmart, Target and Costco.

"We have become obsessive to chase the lowest low prices," says Marian Salzman, trend-spotter and CEO of Euro RSCG Worldwide, according to USA Today.
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Secondly, foreclosures may indicate growing deflationary pressures.

"Any surge in debt-repayment problems are a byproduct of a deflationary trend," says John Lonski, chief economist for Moody's Analytics, USA Today adds.

"The inability to pay off debt usually flows from two things: Either your cash flows are less than anticipated or the value of the collateral declines precipitously."

Unlike inflation, which can be tamed with Federal Reserve rate hikes, deflation often runs a vicious cycle, as falling prices lead to falling output, which leads to less hiring and further price declines.

Other economists agree that deflation, while not imminent, merits watching, as evidenced by the Federal Reserve's hints that it won't rule out a third round of super-loose monetary policies known as quantitative easing to avoid deflation.

"The Fed is right to be worried about deflation," says Michael Hanson, senior U.S. economist for Banc of America Securities-Merrill Lynch.

"It's out there as a risk, but not an imminent risk. We think the Fed has the tools to make it a low-probability event."

Some Fed officials, however, are less concerned.

Given that the job market in December exceeded expectations by adding a net 200,000 net nonfarm payrolls, a third round of quantitative easing remains on the backburner for now.

"The jobs report was encouraging and I’m hopeful that this is a harbinger of more robust activity” in the U.S. economy, says Federal Reserve Bank of St. Louis President James Bullard, according to Bloomberg.

A third round of quantitative easing is not "very likely right now," although officials will weigh the benefits and the costs of such a move, Bullard adds.

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