IF the argument is deflation or inflation – what’s your poison? What is the most likely scenario?

THEN we would continue to discount the specter of outright deflation. I do not believe that deflation is going to be a significant risk even though it may weigh on market sentiment. Further out – 12 to 18 months – the reflationary measures that had been taken both fiscally and on the monetary side will result in slight inflation pressures.  

IF the future happens to prove you wrong, how harmful will deflation actually be?

THEN I would stress that it is not necessarily evil. I can imagine a scenario where we have disinflation for some time, particularly in Western economies.  But, outright, prolonged deflation would be very problematic and have significant societal consequences.

 IF governments worldwide continue to engage in fiscal stimuli, then this must eventually cause inflation.

THEN, yes, particularly if we have debt-to-GDP ratios rising above 100% of GDP. This is starting to concern markets with fears that once the velocity of money starts to pick up, the massive liquidity injections will have inflationary consequences.

IF liquidity remains good and prices for oil and human labor continue to rise, how will this affect inflation?

THEN the combination of these factors will make inflation one of the major issues that central banks will have to deal with mid- to long-term. Rising interest rates could be a burden to the stock market, too.

 IF all of this comes to pass, then what will be the longer-term consequence?

THEN one result might be a return to a different type of monetary policy by the authorities and central banks, for example, a move toward inflation targeting. This probably would mean a slightly higher inflation rate in the longer run to avoid being too close to the disinflationary scenario sometime in the future.

Published by PROJECT M in November 2009

(Illustration: Berto Martinez)