Roubini: How to avoid the horrors of ‘stag-deflation’

Below are a few excerpts from an Op-Ed by Nouriel Roubini from today’s Financial Times.

The U.S. and the global economy are at risk of a severe stag-deflation, a deadly combination of economic stagnation/recession and deflation.

A severe global recession will lead to deflationary pressures. Falling demand will lead to lower inflation as companies cut prices to reduce excess inventory. Slack in labour markets from rising unemployment will control labour costs and wage growth. Further slack in commodity markets as prices fall will lead to sharply lower inflation. Thus inflation in advanced economies will fall towards the 1 per cent level that leads to concerns about deflation.

Deflation is dangerous as it leads to a liquidity trap, a deflation trap and a debt deflation trap: nominal policy rates cannot fall below zero and thus monetary policy becomes ineffective. We are already in this liquidity trap since the federal funds target rate is still 1 per cent but the effective one is close to zero as the Federal Reserve has flooded the financial system with liquidity…

As traditional monetary policy becomes ineffective, other unorthodox policies have be used: massive provision of liquidity to financial institutions to unclog the liquidity crunch and reduce the spread between short-term market rates and policy rates; quasi-fiscal policies to bail out investors, lenders and borrowers…

In the next few months, the flow of macroeconomic and earnings news will be much worse than expected. The credit crunch will get worse, with de­leveraging continuing as hedge funds and other leveraged players are forced to sell assets into illiquid and distressed markets, leading to further cascading falls in prices, other insolvent financial institutions going bust and a few emerging market economies entering a full-blown financial crisis.

The worst is not behind us: 2009 will be a painful year of a global recession, deflation and bankruptcies. Only very aggressive and co-ordinated policy actions will ensure the global economy recovers in 2010 rather than facing protracted stagnation and deflation.

Roubini’s assessment is spot on. Policy-makers would be well advised to heed his prescriptions. However, Germany, for one, thinks it can do without the advised stimulus — fiscal and monetary. Let’s see how they get on in the coming months.

Read the full article below

How to avoid the horrors of ‘stag-deflation’ – FT

  1. Joseph Pietro Riolo says

    I may be off the base but want to know what others think of these articles: and . These articles discussed about the negative interest rate and expiration-dated paper money. Are they worthy to be considered in fighting deflation or are they ridiculous and unworkable?

    Joseph Pietro Riolo
    [email protected]

    Public domain notice: I put all of my expressions in this post in the public domain.

  2. mL says

    I think how much interest rate will be cut in the next FOMC meeting is not important anymore. The effective FED rate already dropped below 0.39%.

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