Will there be inflation or deflation post-vaccine rollout?

Ask an Economist

I am a simple individual with little economic background trying to figure out (predict the likely future) of whether the national U.S. economy is likely to experience inflation or deflation after most states near completion of their vaccine rollout and travel opens back up. Theoretically, the massive quantitative easing and massive stimulus has drastically increased the money supply (https://fred.stlouisfed.org/series/M2) and should result in inflation. Granted, people have been saying the same thing since 2008 and inflation is still low. I have come up with 3 possibilities and would like to hear an economist's opinion.

1) money velocity is low but inflation will soon come when the economy opens up
2) CPI and PCE are broken and are not good measures of inflation. Inflation is already here but reflected in housing, healthcare, and equities instead of milk and eggs.
3) QE actually leads to deflation

1) I thought that perhaps the lack of significant inflation is due to the low money velocity (https://fred.stlouisfed.org/series/M2V). Perhaps once the economy opens up, people will spend more leading to an increase in money velocity, which finally leads to inflation. I have heard that people are saving more since restaurants are closed and travel is dead (https://fred.stlouisfed.org/series/PSAVERT) (https://fred.stlouisfed.org/series/PSAVE). I have also heard that the drastic rise in equities and real estate are due to people spending more on assets. However, if it is assumed that people are saving more, how can net savings as a percentage of national gross income be negative? (https://fred.stlouisfed.org/series/W207RC1Q156SBEA)

2) Perhaps CPI and PCE are broken measures of inflation. At least in California, food is slightly more expensive, housing (whether renting or owning) is very much expensive, and healthcare is stratospherically expensive. Perhaps there already is inflation and everyone is looking at the wrong measurements?

3) Is it possible that QE actually leads to deflation? The rise in equities and real estate has benefited those who already own these assets to begin with (i.e. rich people) and the bottom 90% of people are living off credit, stimulus, and savings. Rich people save more than they spend and thus have a negligible effect on money velocity. Poor and middle-class people spend more and make up 90% of the population; so if they had money to spend, they would spend it, thus increasing money velocity. Is it possible that the bulk of QE is going to rich people who just throw it at equities and real estate while the other 90% gain little from QE. Overall, aggregate demand would decrease for consumer goods. And as stuff that actually matters such as healthcare and housing continue their upward rise, the 90% would have even less to spend on consumer goods, further decreasing aggregate demand. I imagine this is the so-called K recovery. This theory would also explain why net savings as a percentage of GNI is negative. Assuming GNI is still positive (https://fred.stlouisfed.org/series/MKTGNIUSA646NWDB) (the latest data is from 2019), this would mean that net savings is negative and most of the U.S. population is surviving off credit. I imagine that the drastic increase in wealth of the top 10% skews personal savings and personal savings rate, though I have no idea how these are calculated on a national scale.

It is impossible to predict the future, but I would like to hear from an economic perspective why any or all of these theories are wrong.


Inflation is the rate of change of the price level (i.e., the “cost of living” as measured in dollars).  The standard framework economists use to understand price changes is supply versus demand.  For example, if supply of an item (i.e., the quantity supplied at any given price) increases while its demand is unchanged, the item’s equilibrium price will fall.  While this framework is intuitive, applying it to predict future price changes may not be straight-forward.  The reason is that the underlying supply and demand are not fixed, and they are often not observable.

As you note, the money supply in the United States has drastically increased over the past year, but inflation has not.  Why?  It must be that money demand has also increased: individuals have desired to hold more nominal wealth in the form of currency and bank deposits.  Many economic forces may be at work here, such as a desire to delay consumption (due to safety concerns or lockdowns stemming from COVID that made consumption less desirable in 2020), precautionary savings (due to uncertainty about future prospects), and low nominal interest rates (which lower the opportunity cost of holding money).

Whether inflation picks up in the future depends on how money demand and supply evolve.  As COVID concerns abate and the economy opens up, money demand may decrease.  Households (and firms) may attempt to dispose of some of their nominal wealth held in the form of money by increasing their consumption (and investment) spending.  In this case, and all else equal, we would expect the price level to rise.[1]  But, alternative scenarios are possible.  Perhaps money demand stays elevated as households continue to hold more nominal wealth either for precautionary reasons or because they expect to pay more taxes in the future, or perhaps the money supply decreases as the Federal Reserve engages in quantitative tightening (QE in reverse) to keep inflation in check even as money demand falls.

Now, onto your specific questions:

  • Money velocity (V) is defined as the ratio of nominal spending to the money supply (V = PY / M).  If money demand decreases for a given money supply (M), nominal spending (PY) will increase and thus velocity will increase.  Whether this leads to inflation (an increase in P), depends on whether the economy is near its potential.  If the economy is operating below potential (i.e., high unemployment and unused capital capacity), the increase in nominal spending may result in an increase in real output (Y) with no change in the price level (P) as unused resources are put to work.  If, on the other hand, the economy is already operating near potential, too much money chasing too few goods will lead to inflation.
  • Net national saving is the sum of net private saving and net government saving.  While the personal saving rate, and thus net private saving, was extremely high in 2020, the amount of government borrowing (i.e., dissaving) was also extremely high.  When combined, net national saving was negative.
  • Inflation is the rate of change in the (general) price level and does not take into account relative price changes.  While healthcare prices have increased, prices of some other goods in the consumption basket, e.g., consumer electronics, have declined.  Inflation is meant to capture the (expenditure-weighted) average rate of price change.  This is not to say that inflation measurement is perfect.  Government agencies and academic economists are consistently working on improving our measures of inflation.
  • The effectiveness of QE has been a subject of intense debate in both academic and policy circles.  Fabo et al (2020) provide a recent survey of QE research that covers 54 studies which analyze the effects of QE on output or inflation in the US, UK and the euro area.[2]  Averaging across all 54 studies and standardizing QE program size to 1% of the country’s GDP, the paper reports that QE increases the price level by 0.19% at the peak, with the average cumulative effect being 63% of the peak effect.  The peak effect on the price level is positive in all studies, while the cumulative effect is positive in all but a handful of studies.


[1] If money demand decreases with money supply unchanged, the equilibrium price of money (i.e., consumption goods per dollar) will fall.  Thus, the price level (i.e., dollars per unit of consumption) will rise.

[2] See Fabo, Jancokova, Kempf, and Pastor (2020), “Fifty Shades of QE: Comparing Findings of Central Bankers and Academics,” https://ssrn.com/abstract=3693174.

Answered by:
Last updated on March 4, 2021