Get Ready For ‘Stag-Deflation’

When Roubini speaks I listen. I suggest you do the same.

Back in January, I argued that four major forces would lead to a risk of deflation– or “stag-deflation,” where a recession would be associated with deflationary forces–rather than the inflation that mainstream analysts have worried about.

They were: (1) a slack in goods markets, (2) a re-coupling of the rest of the world with the U.S. recession, (3) a slack in labor markets, and (4) a sharp fall in commodity prices following such U.S. and global contraction, which would reduce inflationary forces and lead to deflationary forces in the global economy.

How has such argument fared over time? And will the U.S. and global economies soon face sharp deflationary pressures? The answer: Deflation and stag-deflation will, in six months, become the main concern of policy authorities.

Why?

First, the U.S. has entered a severe recession that is already leading to deflationary forces in sectors where supply vastly exceeds demand (housing, consumer durables, motor vehicles, etc.). Aggregate demand is falling sharply below aggregate supply. The unemployment rate is up sharply, while employment has been falling for 10 months in a row. And commodity prices are sharply down–about 30% from their July peak–in the last three months, and are likely to fall much more in the next few months as the advanced economies’ recession goes global. So both in the U.S. and in other advanced economies we are clearly headed toward a collapse of headline and core inflation.

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