In this weekend’s NY Times, there was a great chart on the inflation trends in the U.S. compared to the inflation trend in Japan after its bubble burst in the early 1990s. The two charts look eerily similar and explain why U.S. policymakers have been so adamant about preventing inflation because if price pressures are left alone, it could continue to fall, putting the U.S. at serious risk of deflation. Americans have already grown accustomed to discounting, putting off their purchases until good deals offered. Changing inflation expectations can be very difficult, which is why the central bank needs to deal with them before they become entrenched. Here are some quotes from the article titled, After QE2, Watching Inflation’s Trajectory.

Deflation is feared for several reasons. If consumers come to expect it, as happened in Japan, there is a strong incentive to delay purchases while waiting for a lower price. That can restrain economic activity and increase unemployment. In addition, deflation places downward pressure on asset prices, worsening the situation of those who are indebted.

As the accompanying chart indicates, the core inflation figures are charting a path roughly similar to one shown in Japan 15 years earlier. That has been true despite a much stronger reaction by the American central bank, which was determined not to make the same mistakes the Japanese made.

 

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.