Monday, July 12, 2010

Krugman, Makin, Deflation, and Wall Street

Paul Krugman has started to cry the alarm about deflation in his column today and in his blog.  (Just to clarify, deflation is distinct from disinflation.  The latter is a slowing down of the rate of inflation, while deflation is the opposite of inflation -- the general price level declines.)  He was impressed by an article economist John Makin wrote for the American Enterprise Institute -- "The Rising Threat of Deflation."  As Krugman points out, AEI is a conservative ("right-wing") think tank.

Makin's article is indeed "scary";  he makes a good case that deflation is very possible.  One hopes that policymakers in the U.S. and in Europe take note of it.  At the end of the article, Makin writes:  "Growth has suffered and subsequently recovered given powerful monetary and fiscal stimulus.  And yet, the damaged financial sector, unable to supply credit; a jump in the precautionary demand for cash; and a persistent overhang of global production capacity have combined to leave deflation pressure intact.  The G20's newfound embrace of fiscal stringency only adds to the extant deflation pressure."

In contrast to this pessimism, The New York Times put on the front page yesterday an article entitled "Wall St. Hiring in Anticipation of a Recovery."  The fixed-income traders at these firms, though, are trading Treasury 2-year notes at a shade over a 0.6% yield, which hardly seems to be a market prediction that we are headed for good times in the near future.

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