With all the ersatz money being pumped into the economy it'd be easy to think that at some point inflation would become a problem, and in theory it will. But I'm convinced that the prospect of deflation, not inflation, is what's keeping Bernanke and Paulson up at night. Here's a quick primer on the flations, I finish up after the jump: Inflation: Prices are rising - A pair of Air Jordans went from $100 in Jan, to $125 in Feb, to $150 in Mar.
Disinflation: Prices are rising, just not as fast - Those same Jordans go to $155 in April and to $159 in May.
Deflation: Prices are falling fast - Those Jordans fall to $135 in June, $105 in July and $85 in August.
Most opponents of the bailout are concerned the increase in money supply will cause prices to rise because there will be more dollars competing for the same amount of goods. I'm not totally convinced of that in this instance, mainly because so much wealth has been destroyed, but in theory this is correct. Fortunately there's a known fix for inflation. Raise the interest rate, make it more expensive to buy money, decrease the money supply and voila bye, bye inflation.
But deflation is like Macaulay Culkin in The Good Son...outright nefarious. It's part of the vicious cycle I've blogged about ad nauseam. With deflation people begin assuming prices will continually drop. So instead of buying that tv today I wait...and wait...and wait, and since it's not something I absolutely need I wait some more. All of this waiting eventually forces prices to the point of loss or nominal profitability for the seller, which in turn causes them to layoff workers, which in turn drives up unemployment and exacerbates the recession and the deflationary spiral further.
The antidote for deflation is the exact opposite of inflation, to lower interest rates and increase the money supply (in essence encouraging inflation). What makes this antidote less effective is twofold. First you can only decrease rates to 0% (unlike its infinite converse), and with rates already low there's not much ammunition there. Second is human emotion. Once society has been conditioned to expect lower prices, it's hard to reverse that course of thinking especially in a recessionary environment where people are already skiddish about spending.
I'm sure there's someone out there reading this thinking "This sounds like an after Christmas sale, what's wrong with waiting for prices to drop?" Nothing. If it's just one cheapo who's waiting for clearance. But if the masses are indefinitely waiting, then they're not spending which is a problem in a consumption economy.
There are few other types of -flation that only the wonkish care about and in general a little disinflation is pretty harmless.
