Deflation And The Fed

Deflation is a big concern in Europe at the time. With Draghi, head of the ECB, waiting to take action on the slowing growth numbers in the region push prices closer to zero. Many of us know the main causes of deflation such as large drops in demand due to recessions or austerity (Europe) or from a decline in spending and lending. But another interesting notions is that of growth deflation.

Growth deflation is something that stems from technological advances and increased efficiencies having supply outstrip demand. Add to this a dose of competition and price declines are bound to happen. We have seen new firms come in over the past several decades and create technologies that allow us to do everything from online banking and shopping to accessing vast amounts of natural resources in areas once thought impossible. This has happened in America in the past with much of the last half of the 1850's in mild deflation (with the exception of the civil war). After the FED was created and took on broader roles in the 1960's the US has not seen significant deflation occur. Despite crises and technological advancements.

If this is due to the FED working to keep deflation out of the economy despite the advances in technology, increases in innovation, and prices dropping drastically on goods due to competition; the government has absorbed much of the price declines through more debt and the Fed expanding its balance sheet. Now the debt is at record levels and the balance sheet has increased 3 fold since the start of the crisis, it seems the most extreme measures have been taken to avoid deflation. Which is good given the amounts of debt now in the global economy. But what if the measures that have been so accommodative to more money and debt not spurring large spikes in inflation stop to produce? If growth deflation stops or slows inflation moving up in a sharper than expected fashion could spur a lot of the money already outstanding to come out of savings and start to increase velocity in a fight for real assets.

In short what if the longer term fight against deflation has sown the seeds for uncontrollable inflation to take root.