Covid-19: inflation or deflation under way?

Efforts to contain economic collapse as a result of Covid-19 have so far entailed unprecedented experiments in monetary policy. While some analysts have warned that this may lead to hyperinflation, others suggest that deflation is a more likely scenario and point at early signs that deflation is already under way.

In the awareness that the 2008 economic crisis was never really overcome, a debate on a future of inflation or deflation had already started prior to the Covid-19 outbreak early this year. This debate has now become more urgent, with Trevor Jackson noting that efforts to contain economic collapse have so far entailed unprecedented experiments in monetary policy. The American Fed is injecting about $1 million into the financial system every second.

One possible scenario is that this will lead to inflationary disaster. According to Jackson, however, “economic history suggests that deflation, not inflation, is by far the more likely – and in some ways the more dangerous – destination”. As the banking community is made up of creditors, for whom inflation is bad, Jackson explains that central banks are more acculturated to seeing inflation as a threat. Inflation being the overriding danger in their perception, recent history has given examples where policy makers accepted higher unemployment as an acceptable cost of avoiding it.

Jackson’s analysis shows that while inflation has been at the center of economists’ education since the 1970s, this does not lessen the dangers posed by deflation. Some of these include falling demand: when consumers expect prices to fall they delay their spending, which ultimately leads businesses to go under because sales dry up. Businesses are anyway discouraged from investing in a deflationary climate because the expected future revenue falls over time and the investments will thus never be worth the high cost. With the amount of a loan staying the same but with wages and prices falling, deflation also makes the burden of debt heavier.

Is the Covid-19 crisis leading us to a similar situation as the Great Depression, when the downward deflationary spiral led prices to fall in the US by about one-third from 1929 to 1933? This question seems all the more relevant as Jackson argues that it was not the 1923 hyperinflation but the deflation a few years later, with the price level falling by about one quarter, which brought the Nazis to power in Germany.

Jackson feels deflation is far more likely than inflation and argues that it is already under way. While Peter Bovinger has recently warned about deflation in the German context, Australia has actually recorded deflation for the first time since 1998, and lower rent and fuel costs have led to the biggest quarterly fall since Australia started keeping records in 1948. Jackson’s analysis is thereforethat “people need direct, universal, unconditional income support. Far from generating a sudden hyperinflation, it may be the only way to avoid a deflationary spiral that rivals the Great Depression”.