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We are fighting deflation, not causing inflation ...yet

Brian L. Giuliano Published on Fri, Jun 19, 2020 / 7:00 AM GMT+8

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(June 19): The global economy has been brought to its knees by Covid-19, with a collapse in demand unlike anything seen since the Great Depression. The International Labor Organization (ILO) estimates that over 80% of the global workforce lives in countries with mandatory or recommended closures. In the US alone, 36 million Americans are unemployed. Given the nature of the health crisis and the absence of vaccines, it is entirely possible — if not likely — that the rebound in economic activity will be lacklustre. A recent working paper by the National Bureau of Economic Research (NBER) estimates that a devastating 42% of pandemic layoffs could result in permanent job loss.

In response to the uncertainty, consumers have cut spending and increased savings, businesses are slashing prices, and wages are under pressure. Deflationary pressures are all around. The environment today is not entirely dissimilar from the early 1930s, the last time a demand shock of a similar magnitude occurred. The good news is that today, unlike the early 1930s, policymakers seem to understand the gravity of the situation, and are acting to aggressively combat both the fall in real output and intensifying deflationary pressures.

In the US, deficit spending this year, as a percentage of GDP, will be close to a 100-year high — eclipsed only by deficits incurred at the height of World War II. If we include the expansion of the Fed’s balance sheet alongside the fiscal response, cumulative monetary and fiscal support in the US is likely to be more than 40% of GDP this year, an astounding figure. Looking around the world, the policy response has been equally potent. In Europe, Germany, Italy, the UK, and France have announced even larger fiscal response packages than the US.