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Tuesday, March 04, 2003

Global Stagdisinflation?

This time its Dick Berner who is hitting the button on deflation. Roach must have the whole team at it by now. The central point is that while the seventies shock, which, in fairness, was much bigger, produced an inflation explosion, with global overcapacity, and soft patch demand, lack of pricing leverage means that the energy shock is more likely to hit growth than prices. The sixty four thousand dollar question then is: why were the seventies inflationary, and why are we now staring deflation in the face. I think we are getting the descriptive level fine, it's the explanatory framework that I think we're still not getting.

A curious paradox is nonetheless unfolding. Unlike in the 1970s, deflation is a bigger risk than stagflation, or than higher inflation, at least for now. In the 1970s, the rise in energy prices hit when lax monetary policy nurtured inflationary psychology and capacity use was high. Industrial operating rates in 1978 exceeded 85% -- nearly 10 points higher than they are today. In contrast, I believe that energy shocks today tax growth more than they boost inflation. The potential for higher energy prices to filter through to costs -- and thus to “core” inflation and inflation expectations -- is one set of forces. But more powerful and working in the opposite direction, an extended period of sluggish global growth, ample capacity, and relatively restrictive policies abroad all argue for lower, not higher global inflation.
Source: Morgan Stanley Global Economic Forum

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