Outcome of the 2007 Financial Crisis : Inflation or Deflation?

Essay by vaniteuxCollege, UndergraduateA+, March 2009

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Outcome of the Financial Crisis of 2007-2008:

Inflation or Deflation?

Roman Speakman-Poon

Money & Banking


Table of Contents

3Abstract �

3Introduction �

4Background of the Financial Crisis �

5Government Bailouts �

6The Case For Inflation �

7The Case For Deflation �

9Comparison to History �

11Investor Sentiment �

11China's Resource Demand �

12Conclusion �

13Figures �

17References �



Will the Financial crisis of 2007-2008 Result in Deflation or Inflation?


Asset bubbles are usually followed by painful economic recessions, and the bursting of the housing bubble in 2006 is no exception. The resulting financial crisis has prompted the Fed to commit trillions of dollars in an attempt to keep the financial system alive. They have lent out billions to try to thaw a frozen credit market, and will probably drop the target federal funds rate to 0.5%. The national debt is now over $10 trillion, and climbing.

However, consumers have tightened their purse strings and hedge funds have been unloading assets. Currently, a debate among economists is whether a predicted deep global recession will cause a vicious cycle of falling prices or if the Fed's monetary policies will cause inflation when the economy recovers. This paper will lay out the arguments for both cases, looking at historical events such as the Great Depression and Japan's Lost Decade as well as current events, including Fed policy and China's economy. By associating economic theory, history, and economic indicators, we will come to a conclusion on whether the financial crisis of 2007-2008 result in deflation or whether inflation will be the more likely outcome due to Fed policy.


The 2007-2008 Financial crisis, similar to the Great Depression and Japan's lost decade, started with the bursting of an asset bubble. An important difference, however, has been the introduction...