Deflation, like inflation can be a serious threat to the economy. Yesterday, we saw how M1 has been expanding fairly rapidly of late.
Notwithstanding its relationship with velocity (which is interesting, but not the focus of this post), we know, from the Quantity Theory that increasing money stock leads to increasing prices. So why is there no fear of inflation this time? Because of current deflation. From EconomPic Data:
However, this is not to say that inflation is not a fear at all. When things turn around, there might be inflationary fears. As Prof. James Hamilton says, on Econbrowser,
In other words, if the Fed decides that, as a result of inflationary pressures, it needs to undo some of the expansion in its liabilities at a time when it is not prepared to unwind its asset positions, Plan B is for the Fed to borrow directly from the public.
Which brings me back to the original question. Does the explosive growth of the monetary base in Figure 1 imply uncontrollable inflationary pressures? My answer: not yet, but stay tuned. [link]
Since inflation is still a while away, and deflation is still very much in the air, here’s an interesting explanation of why deflation can be problematic. Rohan Narayen (from 100B) sent me the link: