Steadfast FinancesIs Inflation or Deflation Worse

Should the Fed be Fighting Deflation or Inflation?

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Welcome to 2012; it’s either time for Ben Bernanke to start QE3 or raise interest rates. Figuring out which one is the best move is not as easy as you’d think.

It was so simple when I was taking classes for my economics degree. When the economy did “X” you, as the Fed, embark on expansionary policy. When the economy did “Y” you retract the money supply. No professor ever made the point that figuring out whether economy is doing “X” or “Y” is not as obvious as you’d think.

What is the Fed Doing?

It seems pretty clear that Ben Bernanke is concerned about deflation. Two weeks ago, he signaled to the market that he was looking at another wave of quantitative easing. To quell some of the inflation concerns, Bernanke did set a target rate for inflation of 2%. We are currently at 1.7%.

However, I couldn’t but help raise an eyebrow to Bernanke’s .3% cushion for inflation, especially as I watch earning results hit the street from last year’s fiscal. Numerous companies like Colgate are complaining about rising raw materials and threatening to raise prices. Could inflation be worse than expected? Would Bernanke, who is mostly concerned about deflationary pressures, start retracting monetary policy if inflation were to rise over 2% this quarter?

Is Inflation or Deflation Worse?

The crux of our dilemma is answering which is worse: inflation or deflation. Different economies have had different experiences with these macroeconomic conundrums. Those experiences have shaped respective policies and practices for better or worse.

The most traumatic macroeconomic event in the US was the Great Depression. It was a time where rampant unemployment led to less money in the hands of average, everyday workers. Without pay, those workers could not afford to buy goods, which caused businesses to suffer and fire more workers. It’s a downward spiral that lasted a decade.

Head to Germany and the hyperinflation of the Weimar Republic is the predominant economic event. Imagine prices skyrocketing so quickly, that the rich were trading pianos for a sack of potatoes. Misery is the only outcome when the price of food starts rising far faster than your paycheck.

The Trouble with Economists

Economics is a field of study where an economist can win a Nobel Prize for an idea and the next decade, an economist can win the Nobel Prize for saying the exact opposite thing. The problem is that there are justified concerns and arguments for both camps.

At a persistent 8% unemployment rate and a still crippled housing market, there seems to be plenty of justification for more expansionary monetary policy. Demand for US currency has only increased the last few years. It offers the hope that our country can sustain a large pool of dollars.

On the other hand, no one thinks that oil and food prices are going to decrease. It’s more of a question of how high will they rise.

It seems as though we are either standing at precipice of a deflationary cliff or the base of an inflationary wall. We just don’t know which.

What’s worse: inflation or deflation? Do you think that we should be battling inflation or deflation?

Shaun is the author of the blog Smart Family Finance, a site dedicated to exploring the challenges of family finance; from starting a marriage to starting a family, from teaching your children about finance to helping them pick a college, from single income to multiple income. The intricate world of family finance unlocked, one post at a time.

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Posted by Shaun   @   16 February 2012 0 comments
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