Deflation vs. Inflation - Which Is the Bigger Threat?

To many people, a deteriorating economy, sluggish bank lending, and widespread frugality indicate that deflation is by far the biggest threat we face. But as Jesse's Café Américain argues in "Some Common Fallacies About Inflation and Deflation: the Weimar Nightmare in Review," history suggests that might not be the case.

There are several fallacies making the rounds of the economic community, often put forward by pundits on the infomercials for corporate America, and also on the internet among well-meaning but badly informed bloggers.

The first of these monetary fallacies is that 'the output gap will prevent inflation.' The second is that a lack of net bank lending or other 'debt destruction' will require a deflationary outcome. Let's deal with the output gap theory first.

Output gap is the economic measure of the difference between the actual output of an economy and the output it could achieve when it is most efficient, or at full capacity.

As far as my two cents goes, one could easily argue that the dollar's long-standing role as a reserve currency means that there are a great many "unnatural" holders of the U.S. currency around the globe. Generally speaking, they require more incentives than Americans to remain invested.

In a world where the U.S. is no longer seen as the leader it once was, where the risks stemming from hyper-expansive fiscal and monetary policies are increasingly apparent and growing by the day, and where many old truths are no longer being taken for granted, it is not a stretch to think that today's demand for the currency could easily evolve into tomorrow's rapidly growing supply.

Comments

[user396040:]

Focusing on inflation now is like focusing on flood prevention during a drought.

Jun 24 03:59 PM

[Jimbo:]

Focusing on flood prevention under the above circumstances may not be a bad idea. The levies around New Orleans were neglected for decades before Katrina came to town.

Jun 25 11:20 AM

[Steve Soden:]

Histroy will record that We had Inflation in some areas of the Economy and Deflation in others at the sametime, which is true today.
Let"s call it INDEFLATION!
The World's Economies are being torn apart by these forces and all we can do is Watch!
At the end of it all 'The Cards' will be on the floor and when we try to pick them up and put them in order again, some will be missing and some New Ones will be there that are Poison!
Things will Truly never be the same again and starting over will be a blessing - if you can.

Jun 25 12:59 PM