Tags: Savage | inflation | deflation | Fed

Personal Finance Expert Savage: Deflation — Not Inflation — Is the Larger Threat

By    |   Monday, 23 September 2013 09:16 AM

Deflation is a larger threat to the economy than inflation is.

The danger of inflation is often cited as a reason why the Federal Reserve should shrink its quantitative easing stimulus. To purchase $85 billion of government and mortgage bonds every month, the Fed essentially creates new money, but the funds remain at the Fed as reserves rather than flowing into the economy and increasing the money supply.

The Consumer Price Index increased just 0.1 percent in August and 0.2 percent in July. It rose 1.5 percent over the past year. The low inflation figure gives the Fed room to continue its stimulus.

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"Best bet is that the inflation number will not impact the Fed's plans, because they know that all that money they've created is just sitting out there on the books of the banks and corporations, waiting to move into action," writes personal finance expert Terry Savage in an article for The Huffington Post.

On the other hand, if "velocity" increases — in other words, the money starts flooding the economy — prices could quickly jump, she adds.

"While low inflation is good for business, if inflation drops even to a negative level — deflation — it would be very bad news for business, and the jobs created by business," Savage warns.

In addition to falling prices, deflation would probably come with falling profits. Businesses would be unlikely to expand, despite low borrowing rates.

As incomes fall, debt will become more expensive for borrowers.

"Deflation hurts borrowers — unless you can print the money to repay your debts!" Savage writes. "That's the strategy being followed by the Fed to help the U.S. government repay its $17 trillion national debt."

Inflation is below the Fed's 2 percent target, although the central bank predicts inflation will increase somewhat in the medium term.

The possibility of deflation, as well as the low labor participation rate, was a major factor in the Fed's decision to continue its stimulus, writes Robert Oak on his Economic Populist blog.

"We are seeing low inflation similar to the deflationary period of 2008, caused in part by the Great Recession and a massive drop in global economic demand."

Investors trying to predict when the Fed will start tapering should take into account its concern about deflation, he advises. "If quantitative easing ends, assuredly inflation will decrease."

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Deflation is a larger threat to the economy than inflation is.
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