There is a myth that during an economic downturn, the one silver lining is that pressure is taken off prices and so inflation rates come down. This mentality oozes from the financial press, and even Ben Bernanke endorsed it Friday during the Group Think session in Jackson Hole, Wyoming. Even though the PPI just hit a 27-year high, the Chairman isn’t worried. From the above NYT article:
Mr. Bernanke, while acknowledging “an increase in inflationary pressure,” reasserted his view that in the near future, the upswing in inflation from the oil and food shocks was likely to moderate.
“The recent decline in commodity prices as well as the increased stability of the dollar has been encouraging,” he said. “If not reversed, these developments, together with a pace of growth that is likely to fall short of potential for a time, should lead inflation to moderate later this year and next year.”
Now folks, I realize this is going to sound crazy at first, but Bernanke’s view is exactly backwards. Other things equal, if you tell me that economic growth is going to slow, then that tends to make prices go up, not down. What is the lay explanation for inflation? “Too much money chasing too few goods.” So during a recession, there are fewer physical units of products and services getting cranked out, while the number of dollar bills (and checking account balances, etc.) hasn’t dropped.
For a fuller analysis, see my previous LRC article on why central banks–the Fed in the US–are to blame for rising prices, not “robust economic growth.” (Incidentally, Ron Paul backed Bernanke into a corner one time, and got Big Ben to basically admit that an increase in real output actually tends to lower prices–because the same stock of money is chasing more goods. Unfortunately, I can’t remember enough about their exchange to find it for you.)
If I’ve got you wavering with my verbal arguments, click on the graph below, constructed with the Fed’s own data. It shows quite clearly that inflation often spikes during recessions.