[The graph above] is not a perfect fit  this is economics, not physics, and anyway stuff besides the output gap bounces inflation around from year to year. But still, thereÂs a clear correlation, driven largely but not entirely by the deep slump and disinflation of the early 1980s, and an implied slope of about 0.5  that is, every percentage point by which real GDP fall short of potential tends to reduce the inflation rate by about half a point over the course of the year.
And right now the CBO is saying that in the absence of a policy action the average output gap will average 6.8 percent over the next two years. Do the math: if anything like the historical relationship between output and inflation holds, weÂre looking at major deflation.
OK, maybe that relationship wonÂt hold  getting to actual deflation may take a deeper slump than merely reducing the inflation rate. And maybe a regression driven in part by 80s data isnÂt a good guide to current events. But deflation is a huge risk  and getting out of a deflationary trap is very, very hard.
We truly are flirting with disaster.
Let's see... -6.8%/2 = -3.4% Current inflation is 0.1%. 0.1% - 3.4% = -3.3% That's huge. And very bad.
I hope the Senate and House get their act together and get a good bill passed soon...
Cheers,
Scott.