Deflation now, inflation later? by Charles Batchelor, research analyst for Milwaukee-based Cleary Gull Holdings Inc.
Highly levered balance sheets caused a near death experience for the U.S. economy as the housing bubble burst and the value of derivative securities tied to the housing market plummeted.
In the wake of the crisis, a new debate emerged. Will the U.S. economy find itself suffering through deflation because of continued deleveraging? Or, will the massive amount of liquidity and easy monetary policy implemented by the government in response to the crisis result in rapidly rising inflation?
Economists siding with deflation argue that deleveraging, minimal wage growth, a weak housing market, excess capacity and high unemployment will result in falling prices. Falling prices cause consumers to postpone purchases, which cause prices to fall even further. Businesses then suffer from a decline in sales and smaller profit margins, which incentivize them to cut production and layoff employees. This vicious deflationary cycle is difficult to recover from.
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