Special Commentary: Could the U.S. economy be facing deflation?

Executive Summary

If history is any guide, the economic weakness stemming from COVID-19 should put downward pressure on rates of consumer price inflation. Indeed the year-over-year change in the consumer price index slid in April to its lowest rate since 2015. Some observers worry that the U.S. economy could be on the cusp of deflation, which is a sustained decline in the economy’s overall price level. Although consumer price inflation is set to slow this year, the U.S. economy should skirt outright deflation. In this report, we discuss downside risks to our inflation outlook.

Deflation or Disinflation?

The steps taken to combat the spread of COVID-19, specifically the stay-at-home orders that have shuttered many businesses, are leading to significant weakness in economic activity. As we discuss in our recent Monthly Economic Outlook, we look for real GDP, which fell at an annualized rate of 4.8% in Q1-2020, to nosedive 25% in Q2 and for the unemployment rate to average 17.6% during the quarter. If history is any guide, this economic weakness should put downward pressure on rates of consumer price inflation. Data released on May 12 show that overall CPI inflation fell to 0.3% in April, the lowest year-over-year rate since 2015 (Figure 1). The “core” CPI, which excludes volatile food and energy prices, tumbled 0.4% in April, the largest month-on-month decline on record. On a year-ago basis, core CPI inflation slipped to 1.4%, the lowest rate in nine years.

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