Forget about Inflation, Deflation Is the Real Threat, BofA Says

The gargantuan rescue efforts from the federal government and the Federal Reserve have invited the usual fears that, at some point, inflation will result. But a key Bank of America economist begs to differ.

Nonetheless, possible inflation is the subtext of current skepticism on Capitol Hill about any more federal spending to counter the economic destruction COVID-19 has wrought. And in a LinkedIn video last month, billionaire Ray Dalio said inflation eventually will kick in (although he backs the big government spending as necessary). Higher interest rates and a lot of debt could well bring back inflation, said the founder of Bridgewater Associations, the world’s largest hedge fund operation.

To BofA, however, such fears are groundless because inflation and its brother, low rates, are here to stay for some time. “We continue to be struck by the almost reflexive argument that easy macro policy will inevitably be inflationary,” wrote Ethan Harris, head of global economics research. He noted that the same inflation forecasts cropped up amid the 2008 financial crisis, when policymakers delivered a torrent of Washington aid—and yet no such thing occurred.

In fact, he went on, the “COVID crisis and the policy response to it are disinflationary, and in the next couple of years outright deflation is a bigger risk than serious inflation.”

Recent data supports the plummeting of inflationary forces, he argued. The core Consumer Price Index (that’s the one without volatile food and energy costs) slid 0.45% in April, “the weakest number since the data started in 1957.” This is on top of a 0.10% decline in March.

Meanwhile, headline CPI, the one that includes everything, was down 0.8% last month and 0.4% in March. Over the past two months, producer prices have descended even faster, off 1.1% for core and 1.5% for headline.

Harris noted that surveys show the public’s inflation expectations are on the rise. Items associated with the economy’s shutdown, of course, namely grocery and cleaning products, have risen in price. But, as Harris described the dynamic, “plunging energy prices offset increasing prices for food at home.”

What’s more, he indicated, “Less visible are the numerous falling prices. For example, some people have been unable to pay their rent, pushing down the average paid price of housing services.”

Deflation has been a bugaboo of the Federal Reserve ever since the financial crisis. The last era of steadily dropping price, during the 1930s, was economically ruinous. People’s incomes (if they had any) were falling, but their debts stayed at the same level, providing pain that prolonged the Great Depression.