I am certainly of the view that a considerable worsening of the recession is baked in the cake for 2009. But will fiscal and monetary stimulus prevent worst case scenarios? I certainly hope so, as I have laid out in recent posts.
But, don’t take my word for it. The RGE Monitor headed by Nouriel Roubini, the omni-present Professor of Finance at New York University, weighs in on this with a recent post. Below is the first snippet of that post where they lays out their argument.
Central banks around the world have undertaken a number of measures to forestall deflation and lift the global economy out of economic slump and credit crisis. Aside from traditional monetary policy tools such as official interest rate cuts and relaxations in reserve requirements, central banks have resorted to alternative unconventional tools. Quantitative easing has begun in the epicenters of the credit crisis, U.S. and Europe, who may be joined by other central banks as they too head towards zero interest rates in leaps and bounds (Sweden moved the most in the developed world by 175bp in one shot). With monetary policy transmission broken by the unwillingness of the private sector to lend or borrow, central banks have had to scurry for alternatives to rate cutting in order to restore markets. They set up an alphabet soup of liquidity facilities that lend funds or purchase assets, offered guarantees on deposits and loans, and established currency swap lines, in addition to a host of fiscal stimulus packages announced by governments. Check out “Policy Responses to the Global Credit Crisis”
So are the pieces now in place to prevent global stag-deflation? It is too soon to tell. So far, money market and commercial paper markets have shown tentative signs of easing. But elsewhere in the private sector credit market, tensions remain as asset prices move shambolically and deleveraging drags on among households, banks and businesses. Though money supply has grown, the velocity of money has slowed despite the flood of liquidity from central banks and official interest rates effectively at or near zero. In other words, we have fallen into a liquidity trap. Such a blow to consumer demand makes deflation in 2009 a real possibility.
So, it seems stag-deflation should still be a concern. But stimulus certainly may help. The post goes into much greater detail and I have provided a link below. Roubini’s RGE Monitor is a good site for economic information. So, I suggest you register for it and read the rest of the post.
Source
Will Aggressive Monetary and Fiscal Measures Prevent Stag-deflation in 2009? – RGE Monitor