I Thought Deflation Was a Fairy Tale

Is deflation just a fairy tale used to scare children, like threats of Hannibal? Not so, last month the CPI fell by 1% in October. Even after excluding food and energy it fell by .1%. Aron, Janine and Muellbauer, John (2008) in "The Next Collapse: U.S. Price Inflation," The Economists' Voice: Vol. 5 : Iss. 6, Article 9 foresee a record fall in prices over the next 6-12 months. They caution that this may not be all bad.

It seems unlikely that governments in China and similar emerging markets can compensate swiftly enough to boost domestic consumption. And with growing over-capacity, investment in goods production may fall even further, with serious implications for GDP. Hence the demand for commodities, which has been driven by emerging market growth, will fall sharply, and help decrease global inflation. Eventually through this channel, lower commodity prices and lower inflation will act like a huge tax cut for households, allowing interest rates to fall further and thus stabilise economic activity. Paradoxically, the faster oil prices now fall, the shorter will be the subsequent period of deflation, as further damage to the economies of industrial countries is avoided.

See also “U.S. price deflation on the way.”