Allen Sinai, PhD
Allen Sinai, PhD, CEO and chief global economist at Decision Economics, Inc., a financial advisory firm based in Boston and New York City. He has been an adviser to several US presidential administrations. DecisionEconomicsInc.com
The deepening recession will cause a lot of pain, but it also will reduce upward pressure on a wide range of prices over the next year, giving consumers some relief.
The slump has already very visibly caused high prices for oil, gasoline and minerals — including gold — to back off sharply, and home prices have plunged over many months. Consumers will also see lower prices for autos, appliances, furniture and various other discretionary items.
Over the next six months, I expect the Consumer Price Index (CPI) to rise at an annual rate of 3% to 3.5%, and over the next year, around 2%. In October, the CPI actually fell by a record 1%.
Rising joblessness will put further downward pressure on prices. In the short term, the unemployment rate will probably increase to near 8% from its recent 6.5%. This will reduce the pressure on companies to raise wages — which, in turn, reduces pressure to raise prices. And, when people lose their jobs, they spend less, which also leads to lower prices.
However, we are planting the seeds of what may later become much higher inflation. To loosen the credit crunch, the Federal Reserve has already slashed its key interest rate target to 1% and may go lower. The federal government is spending hundreds of billions of dollars to rescue the financial industry, and we will probably see more fiscal stimulus in the form of tax cuts and heavy government spending on infrastructure as the new administration and Congress set new policies. Every country in history that has put huge amounts of stimulus into its economy has faced an inflation problem later on.
When economic growth picks up again in 2010, inflation will pick up, too. And unless policymakers step on the brakes quickly and hard, I think it might well get out of hand.
For now, the Fed must cut interest rates, since stimulating the economy is the top priority. But countries that inject enormous monetary stimulus and stay in deep debt are prone to punishingly high inflation. That’s the long-term risk we have to keep our eyes on.
