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Americans want prices to go down, but deflation could spark a wave of unemployment, top economist Paul Krugman says
By Jennifer Sor,
13 hours ago
Falling prices could bring on a spike in unemployment and wage cuts, according to Paul Krugman.
The Nobel economist pointed to pressure from consumers to lower high prices.
The US appears to be entering a soft landing, he said, where inflation eases without a rise in unemployment.
Americans hate high prices — but there's a reason people should hope the cost of goods and services don't drop back to pre-pandemic levels, according to Nobel laureate Paul Krugman.
But asking for prices to return to their pre-pandemic norm could might not be wise, Krugman said. That's because achieving lower prices would require the US economy to experience a "major episode" of deflation , where consumer prices are outright falling — something that has historically been linked to a sharp rise in unemployment.
Such was the case in the US in the early years of the Great Depression , when economic activity ground to a halt. At its worst, the unemployment rate soared to around 25%, while consumer prices fell as much as 25%, according to Fed data.
'"[T]he historical evidence is clear: Imposing significant deflation on a modern economy leads to very high unemployment," Krugman wrote.
Deflation's effects on the job market are largely because falling prices require a drop in wages. The same phenomenon occurred in Greece during its debt crisis , when wages dropped significantly while employment climbed to a peak of 27%.
"So can we make America affordable again, in the sense of getting prices back to what they were before the pandemic? Almost surely not, nor should we try," Krugman wrote. "It was important that inflation not get entrenched in the economy, and it didn't. Instead, we seem to have achieved what many thought impossible: a soft landing that combines low inflation with low unemployment."
Prices remain higher overall, but the pace of inflation has slowed dramatically over the past few years. Consumer prices grew just 3% year-over-year in June , close to the Fed's 2% price target. The unemployment rate, meanwhile, remains near a historical low of 4.1%.
Wall Street has grown more confident that the economy is poised to see a soft landing — a dream scenario where inflation falls without a significant rise in unemployment or a recession. Still, risks stemming from high interest rates linger, with the New York Fed pricing in a 55% chance the economy could enter a recession by June of next year.
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