Get ready for the biggest economic and financial roller coaster of all time. Policymakers in the United States and around the world are opening up the monetary spigots full bore and limbering up spending packages on an unimaginable scale. This comes after more than a decade of low interest rates. In the United States, Congress has passed a $2.2 trillion pandemic package.
Let’s assume for the moment that progress is made on the health front against COVID-19, since the alternative is too horrifying to think about. If we look out ahead, are Americans moving into an era of amazing deflation, stunning inflation, or both?
In the short run, the sheer disruption of the sudden lockdown advocated by the health experts is going to send both demand and prices plunging. Goldman Sachs is forecasting a 24% plunge in GDP in the second quarter. Domestic demand for non-food, non-health goods will collapse, export demand will fall, factories will close. It will be a moment of supreme deflation, combined with an overwhelming–and deeply saddening–surge in virus-related deaths.
But then, like a tsunami wave, trillions of dollars of Federal Reserve funding and Treasury payments to individuals and businesses will finally come roaring onto shore. Demand should soar for all sorts of goods and services that the global economy is too disrupted to provide in quantity. The most likely outcome: A new era of rising prices like we have not seen since the 1970s.
That surge of inflation, if it happens, will present policymakers with a very tough choice–tighten up monetary and fiscal policy and potentially send the economy back into recession, or accept the inflation surge. The choice won’t be a choice–higher inflation will seem infinitely preferable to another downturn.
Instead, if we’re lucky, we’ll see a slow 3-5 year withdrawal of fiscal and monetary stimulus, as government loans are paid back, budget deficits are reduced, interest rates are raised, and excess funds are withdrawn from the financial system. Eventually the global economy comes back to normal–whatever normal will be.
