Tuesday, October 21, 2008

The Financial Rescue Program is Not Inflationary

Our optimism regarding the current financial crisis received a boost with the recognition that a more comprehensive and global approach was needed to restore confidence to global financial markets. Interbank lending rates are receding, a very positive development.

Some observers, however, have expressed concern that the bailout program will rekindle inflation as Central Banks “print money” and sovereign governments run large budget deficits. We do not share that worry. Global population and labor force growth have both been decelerating for more than 30 years, a development that is fundamentally disinflationary. As we wrote recently (Inflation is Not a Problem, August 2008), the recent uptick in inflation was the result of an extended synchronized world business cycle. It was already near an end prior to the crisis. The global environment is fundamentally disinflationary.

Inflation is in remission as was confirmed by the latest reading on the CPI for both the US and the Eurozone. The sharp decline in commodity prices, especially oil, will result in negative readings for the headline series. Neither core inflation nor wages were ever a problem.

The decline in inflation will also substantially increase the ability of Central Banks to further slash interest rates which will both help the current financial crisis as well as the spreading global slowdown in economic activity.

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