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What You Need to Know About the Fed and Deflation

Current Events Macro


• The Federal Reserve's recent actions could lead to a decrease in the money supply, which would cause deflation.

• This is a result of the Fed selling assets back to non-bank entities (average Joe and Jane) as part of their quantitative tightening program.

• If this happens at the same time we go through a recession and banks issue less credit, it amplifies the problem even further.

Deflation is an economic term used to describe a decrease in the value of money. It is the opposite of inflation, which results from an increase in the money supply.

Recently, there has been much discussion about deflationary pressure due to the Federal Reserve's actions.

In this blog post, we will examine how these actions are likely to lead to a decrease in money supply and what effects it might have on consumers and businesses.

How the Fed’s Actions Could Lead To Deflation

The Federal Reserve's quantitative tightening (QT) program is its current program for reducing its balance sheet by selling assets back to non-bank entities.

This means that excess money that was previously available from bank reserves is no longer available and thus decreases the amount of money in circulation. This can significantly impact prices as demand for goods and services drops due to decreased purchasing power.

This reduction in money supply could be amplified by decreased credit issuance during a recession, as banks become more reluctant to lend out funds due to increased risk associated with a sluggish economy.

With less credit available, businesses will find it harder to expand and hire new workers, resulting in fewer purchases and job losses.

Industries such as retail, hospitality, and travel are particularly at risk of experiencing deflationary pressure due to decreased consumer spending.

Consequences of Deflation and What To Expect

Deflation typically leads to lower prices across all sectors of the economy, but it also reduces demand since people wait for further price drops before making big purchases or investments. This can have lasting negative impacts on economic growth since it stunts investment activity over time.

Consumers should prepare themselves for an extended period of deflationary pressure by focusing on hard assets rather than investing their money into speculative stocks or other financial instruments until prices stabilize or start increasing again.

In conclusion, deflation occurs when there is a decrease in money supply due to factors such as quantitative tightening programs enacted by the Federal Reserve or reduced credit issuance during recessions.

The effects of deflation include lower prices across all sectors of the economy along with decreased demand for goods and services resulting from decreased purchasing power among consumers—which can have long-term negative impacts on economic growth if not addressed appropriately by policymakers in time.

For a more thorough explanation of why you should be worried about deflation in 2023, then please watch George Gammon's latest whiteboard video above.