Declining inflation keeps the Fed on hold. Many market participants believe that aggressive monetary stimulus and a sliding dollar hint that inflation may soon rise. Moreover, the sharp downward revisions to GDP over the past year imply that productivity growth decelerated from 2.8% at the start of the recession to only 1% over that period, rather than the nearly 2% implied by previous output estimates. Some may view this deceleration in productivity as the start of a sustained decline in trend, suggesting that stagflation is a risk. Instead, we believe that the deep recession means that inflation, already declining significantly, will decline further in coming months. Updated estimates of ‘core' consumer prices show a deceleration to 1.6% (year over year) in 2Q, a full percentage point lower than a year ago. The deeper the recession, the more slack in the economy, even if measured imperfectly by the output gap - the difference between potential
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