The Economic Battle: Deflation Vs. Inflation With the consumer price index coming out today, the debate among some economists is whether we are headed into a deflationary or an inflationary cycle? We speak with two economists with differing opinions on the matter.
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The Economic Battle: Deflation Vs. Inflation

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The Economic Battle: Deflation Vs. Inflation

The Economic Battle: Deflation Vs. Inflation

The Economic Battle: Deflation Vs. Inflation

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With the consumer price index coming out today, the debate among some economists is whether we are headed into a deflationary or an inflationary cycle? We speak with two economists with differing opinions on the matter.

ALEX COHEN, host.

From NPR News, it's Day to Day. The Consumer Price Index is out today, and the Labor Department finds that prices keep falling for everything from clothing to cars. That's quite an about-face from the last summer, when the cost of food and fuel was high and inflation was a major concern. Where prices are headed is anyone's guess and the source of much debate, as NPR's Yuki Noguchi reports.

YUKI NOGUCHI: The price of gas has fallen a lot, and retailers slashed prices during the holidays, and that's given some relief to consumers amid this recession. But Richard Marston thinks the silver lining for consumers will be short-lived. He's a professor at Wharton Business School. He says in the near-term, people and businesses simply won't buy.

Dr. RICHARD MARSTON (Finance and Economics, Wharton Business School, University of Pennsylvania): Because of the drop in aggregate demand, the immediate impact is going to be a drop in prices.

NOGUCHI: As inventory sits, prices will remain low for several months. That's the immediate impact. But Marston says the real demon lurking behind the next corner is inflation. Here's why.

Dr. MARSTON: They have pumped an awful lot of liquidity into the system.

NOGUCHI: The "they" in the scenario is the Federal Reserve. Its response to the sudden drought in credit was to take unprecedented steps to make money more available and at cheaper rates. They basically created a big pool of new available money. But the banks didn't take that new money and flood the market with new loans. Instead, they put a lot of it in reserve, parking it in safe things like Treasury bonds. But when things improve and banks feel at ease about lending again, Marston said all that extra money supply could very rapidly reverse all current trends. Suddenly, the money will be in circulation, people will spend it, and that could push up prices. If and when that happens, very quickly, the Fed will have to slam on the breaks.

Dr. MARSTON: How does it do it? It's going to be difficult, because it has expanded its balance sheet to such an extent there's now $2 trillion worth of funding on the Fed's balance sheet.

NOGUCHI: To avoid inflation, he says, the government has to find a way to essentially drain about a trillion dollars from the money supply it helped create. But this inflationary scenario is not one Deutsche Bank senior economist Torsten Slok anticipates.

Dr. TORSTEN SLOK (Director, Global Economics, Deutsche Bank): All four forces that normally explain inflation are actually all saying that inflation will not be a problem.

NOGUCHI: Slok cites rising unemployment and very low oil prices. Also the dollar is relatively strong, which keeps U.S. prices down. Finally, by a number of measures, businesses and market watchers aren't forecasting high inflation. Slok says, if anything, U.S. policymakers need to be more worried about a deflationary cycle. If prices keep falling, both consumers and businesses will delay buying or investing, and that in turn could lead to a very prolonged downturn, like Japan through the 1990s. So, which is it, rising or falling? Either way, Slok says, the Fed remains concerned about inflation. Fed Chairman Ben Bernanke said so earlier this week. So, Slok believes that when inflation rears its head again, they'll be ready with a solution.

Dr. SLOK: We are seeing a recovery and inflationary pressures again. Then what central banks will do is start raising interest rates again.

NOGUCHI: Thus making money more expensive, he says, which will dampen prices again. But there's no precedent for handling an economy like this one. So, no one can know for sure, which at this point is the consensus. Yuki Noguchi, NPR News.

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COHEN: Day to Day returns in a moment.

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