Deflation Is What Keeps Central Bankers Up at Night, Says David Blanchflower


By Rob Gowen, CFA

Economist David Blanchflower Discusses the Risk of DeflationAmong financial market participants, fear of inflation seems ubiquitous. But at the 64th CFA Institute Annual Conference today, Dartmouth University economics professor David Blanchflower contended that we in fact “need a good dose of inflation” to help the global economy grow.  Inflation will give central bankers the opportunity to raise interest rates, which is critical, he argued, because with global rates hovering near zero central bankers lack a critical tool to help stimulate the economy.

Another benefit of inflation: it will help real estate owners around the world recover from their negative equity positions, Blanchflower said.

The Dartmouth professor and former member of the Bank of England’s Monetary Policy Committee pointed out that economists vastly underestimated the crisis — and, looking ahead, have a far too optimistic outlook for growth. Curbing expansionary policies and moving more towards austerity measures increases the risk of a double-dip recession. If that were to occur, the global economy would take a deflationary turn, which is extremely challenging for bankers to address. Austerity measures only compound the problem, Blanchflower argued. In fact, he contended that if policymakers do not do more to stimulate the economy, we run the risk of repeating what happened in Japan. Blanchflower believes the U.S. Federal Reserve ought to initiate QE3 — and possibly QE4.

Economist David Blanchflower at the 64th CFA Institute Annual ConferenceAccording to Blanchflower, interest rates are likely to stay low for the next several years. Rising oil prices do not indicate inflation because there are no secondary effects from those higher prices. Only when wages begin to rise will central bankers feel comfortable hiking rates, he said.

In a contrarian call, Blanchflower argued that the immediate risk to the global economy is deflation, not inflation. The problem is that political cycles are shorter than economic cycles and politicians want to reduce deficits. That is a very risky objective given the tenuous footing on which the global economy currently stands, he said. “Deficit reduction in the depths of a once-in-a-hundred-year recession may well be a major mistake,” Blanchflower added.

Which leads to the key challenge for policymakers: The global economy needs growth and a little inflation. But growth comes from lending or spending — and neither banks nor governments seem willing to do either right now.

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