There is a spectre haunting the US which weighs on the US like…

No, not socialism: deflation.  The CPI fell by one percent in the US during the month of October.  For all those economic undergrads out there.  When you go to class tomorrow ask your prof two questions: (1) what he (or rarely she) thinks the NAIRU is for the US and (2) what the marginal productivity of capital is in the US.  Ask both questions again when the fed cuts to nominal interest rates to below 0.  When and if that happens ask a follow up question about the tax implications.  And if you want to be a real jack-ass about it ask your prof in the form of a multiple choice question.

But seriously if the NAIRU is good when inflation is positive it ought to be good when and if inflation goes negative.  The policy conclusion being that there are not enough price rigidities in the US economy.  Time to revamp industrial relations and legislate the unions and the welfare state back in no?  Think that is cheeky? Nope just the inverse of the cure for inflation.

Fed vows to fight against deflation

By Krishna Guha in Washington and Michael Mackenzie and Nicole Bullock in New York

Published:  Last updated: November 19 2008 21:33

The Federal Reserve will do whatever it takes to ensure the US does not fall into a deflation trap, its vice-chairman said on Wednesday, as US stocks fell to the lowest level of the financial crisis.

The comments by Don Kohn will reinforce expectations that the US central bank may cut interest rates again by as much as 50 basis points from the ­current level of 1 per cent in December.

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