Why Bernanke can't stop deflation

While there are many risks to the current ultra loose money policy, consumer price inflation isn’t one of them.  Inflation remains persistently low despite the best efforts of central banks to increase it.

The Consumer Price Index (CPI) among the G7 economies was only 1.6%, year over year, during February.  It was even lower at 1.4% excluding food and energy, according to economist Ed Yardeni.  Meanwhile Producer Price Index (PPI) inflation rates are close to zero, Yardeni points out.  In the euro zone, the CPI inflation rate is just 1.7%, and 1.4% excluding food and energy.  Japan continues to experience deflation despite continuous efforts at reversing it through monetary easing. 

“In the Brave New World (BNW),” writes Yardeni, “pumping more liquidity into financial markets won’t stop consumer price deflation, but it will inflate asset prices, a.k.a. asset bubbles. Central bankers like Ben Bernanke at the Fed and Haruhiko Kuroda at the BOJ are still using models based on the 1930s. They are clueless about the BNW.”  Yardeni believes this is why central bankers are so committed to doing whatever it takes to avert deflation. They fail to realize that productivity-led deflation should be welcomed as the best way to boost the purchasing power of consumers, thereby increasing government tax revenues. 

The Bank of Japan recently voted to flood its economy with freshly printed yen in an effort to reverse the country’s 20-year deflationary trend.  BOJ Governor Kuroda has previously said that he would do "whatever it takes" to drive growth in Japan.  The central bank underscored its commitment to fighting deflation by announcing that it would also buy riskier assets such as ETFs and REITs.  The move toward an even looser monetary policy by BOJ, while decreasing the value of the yen, is also expected to decrease the prices of its manufactured goods sold abroad.  That would be a boon for U.S. consumers but Japan’s move could also hurt U.S. exports. 

Japan’s latest move illustrates how deflation isn’t actually stopped by central bank intervention – it’s merely exported.  Moreover, the CPI trend for G7 economies shows that try as they may, central bankers are simply unable to reverse the deflationary impact of the 120-year mega cycle which is in its final “hard down” phase through late 2014.  

As the crisis in Cyprus recently reminded us, don’t underestimate the long-term Kress cycle.  Also, don’t overestimate the ability of central bankers to inflate their way out of deflation.