Inflation Is Whipped
— for Now.

Consumer
prices worldwide are falling at a record pace. That leaves little to fear
from inflation in the short term, even while debate continues over whether inflation
or deflation is the biggest threat to economic recovery.

Just look at
these recent statistics:

  • Eurozone inflation has turned negative, leaving inflationary
    pressures in continental Europe lower “than at any time since at least the
    early 1950s,” notes the Financial
    Times    .     

    U.S. consumer prices fell 1.3% in the 12 months to May, the
    biggest drop since 1950.


  • Japan’s consumer prices in May saw  "the sharpest
    decrease since comparable figures were first compiled in 1971," Bloomberg
    reports.
  • Inflation in the Gulf region in recent months dropped from
    double digits to low single figures, notes the FT. “In the United Arab Emirates, inflation has tumbled from a
    20-year peak of 12.8% last year to     1.9% in April. Morgan Stanley
    last week forecast deflation of -6.4% for 2009 for the UAE, and -1% for
    2010.

Meantime,
the war of ideas continues to rage over the prospects for inflation vs. deflation. Some analysts believe an economic recovery is imminent, accompanied by the threat of hyperinflation as a result of the heavy monetary and fiscal
stimulus. Another group of observers thinks
the downturn could well drag on for years, with possibly a weak, temporary uptick from the
U.S. fiscal stimulus package. They tend
to see deflation as one of the main forces holding back the economy.

Still others
think we are in for a period of deflation before an economic recovery and a serious
bout of inflation sets in (see this Knowledge at Wharton article, "Deflation Fears:
Could Falling Prices Let the Air Out of a Recovery?"

Franklin Allen, Wharton professor of finance and economics notes, “I think we are in for both deflation and
inflation. The precise sequencing and way in which this will play out is
very unclear. Money supply is up dramatically in the U.S.
Nevertheless prices are continuing to fall here and in other parts of the
world.”

Mauro F. Guillén,
professor of international management at Wharton, says the immediate threat “is the potential for sustained deflation. This is bad
because both consumers and investors will stay on the sidelines waiting for
prices to fall further, and that would reduce economic activity. That’s why
many governments are using a fiscal stimulus to get the economy going again.
But as governments spend more money, they need to borrow it because tax
revenue is also falling. So in the medium term, expect some inflation because
of government borrowing and/or ‘quantitative easing’ — i.e., printing money.”

Last week San Francisco Federal Reserve
Bank president Janet Yellen, who has been discussed as one of the top
candidates to replace chairman Ben Bernanke, had this to say in a speech to the Commonwealth Club of California.

“Just a short time ago, most economists were
casting a wary eye on the risk of deflation — that is that prices might drop,
perhaps falling into a downward spiral that would squeeze the life out of the
economy. Now, though, all I hear about is the danger of an outbreak of high
inflation. I think the predominant risk is that inflation will be too low, not too
high, over the next several years. I take 2% as a reasonable benchmark
for the rate of inflation that is most compatible with the Fed’s dual mandate
of price stability and maximum employment.”

And, though this speech was given before last
Thursday’s disappointing report that unemployment rose to 9.5%, Yellen also
noted that “

With unemployment already
substantial and likely to rise further, the downward pressure on wages and
prices should continue and could intensify. For these reasons, I expect core
inflation will dip to about 1% over the next year and remain below 2% for
several years. If the economy fails to recover soon, it is conceivable that
this very low inflation could turn into outright deflation.”