Much Ado About Deflation

Much Ado About Deflation

almost 4 years ago2 mins

As oil prices sit at historic lows and the US approves another $500 billion economic rescue package, the once-controversial “modern monetary theory” (MMT) looks set to be put to the test – but the end result is anything but certain… 😰

What does this mean?

The price of oil has collapsed this year. Its centrality to the global economy, combined with lower demand for other things, means that inflation, already lower than ideal in many countries, is falling fast.

Economists warned on Wednesday that UK inflation could sink to 0.5% this year
Economists warned on Wednesday that UK inflation could sink to 0.5% this year

Central banks and governments are digging deep to put money into people’s pockets. But even those businesses still operating through the coronavirus are facing pressure to cut prices – and that could turn disinflation into deflation 🎈

Lower prices sound great in theory – but in practice, people simply stop buying if they think things will get even cheaper in the future. Such a downwards spiral would likely damage economic growth further – and many authorities are now plowing ahead with spendthrift MMT-style approaches in an attempt to prevent it.

Why should I care?

The problem is, MMT is largely untested – and it could ultimately cause hyperinflation, rapidly making savings worthless. It’s controversial stuff, but the idea is that governments and central banks should abandon balanced budgets, instead borrowing and printing as much money as they like so long as it’s put to economically productive use.

The US, like many countries, is no stranger to overspending
The US, like many countries, is no stranger to overspending

In order to avoid having that extra cash chasing the same goods and services – which would spark inflation – MMT proponents have previously posited a combination of guaranteed job programs (producing more stuff to buy) and spending-friendly tax cuts.

These too are now becoming reality. But the real test may be after the coronavirus crisis passes, when governments face the difficult task of raising taxes to both pay off their debts and stop inflation rising… 🤔

Investors would do well to bear this in mind in the years to come. But for now, check out our Pack on Economic Theories for more on MMT – as well as other potential solutions to the present conundrum.

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