Right now we are not in deflation. We are in inflation.
What is the deflation rate right now? (United States) http://www.tradingeconomics.com/Economics/Inflation-CPI.aspx?Symbol=USD
Look at that website and it will tell you the rates from January 2010 to December 2010 and also talks about the United States falls to a record low.
What causes the deflation?
Deflation is nothing but a fall in the general price level. In order to understand the circumstances under which Deflation occurs and affects an economic condition, one needs to go through the causes of Deflation. Causes of Deflation:
Capitalism characterized by sufficient existence of competition, is regarded as one of the factors responsible for the emergence of Deflation. In this case, with the improvement in the capital stocks, competition increases million fold. Escalation in the total number of competitors boosts up the supply of goods, indicating that the prices must decrease in order to stabilize the demand, thereby bringing in Deflation. Capitalism also brings in innovation and efficiency, which also contributes towards the initiation of Deflation.
In an economy based on credit, a decrease in money supply results in remarkably less lending trend, followed by a sharp decline in the money supply. As a result, there occurs a sharp reduction in the demand for goods. A decline in the demand is followed by a decline in the prices, owing to the development of a condition called the supply glut. Gradually, this assumes the form of a deflationary spiral, where the prices go down below the costs of financing production.
With the advent of deflationary spiral in an economy, the commercial sector of the country stops incurring profits, despite lowering the prices of their finished products. Ultimately, a situation arises where this commercial sector is forced to become liquidated. In order to prevent or slacken down the deflationary spiral, it is necessary for the banks to avoid the collection of non-performing loans.
According to the monetarist viewpoint, Deflation occurs when there is a decrease in the velocity of money, and/or in the amount of monetary supply per person. Deflation helps the economy grow and develop at a rapid pace, even faster than the creation of hard money.
To sum up, deflation arises due to the following conditions stated below:
Decrease in the money supply
Increase in the supply of goods
Fall in the demand for goods
Escalation in the demand for money
What should the Fed do?
If the economy is a signal processor, then the Fed's job is to compute the lower end of the yield curve such that the total curve is most like Normal, Zero mean. It computes the lower end of the curve with open market operations. The economy, because of finite precision, presents to the Fed a higher or lower basic sampling rate, at the low end. The Fed must assume a deflated or inflated economy, thus selecting the shortest sampling period, or highest sampling rate. It should deliberately sample at twice that rate, approximately.
Distribute a finite set of terms over an ex-post banker yield curve, allocating precision using Shannon. Then look at the optimum set, select the shortest of the terms, and shoot for that. The implicit assumption is that the bankers are doing maximum entropy spectral analysis along the axis in time.
What does that mean? At each term, the banker is trying to determine the "how often and how much", over a specific time period. Business plans compute that in predicted cash flow. The whole banking channel, wholesale, retail, and intermediates, in totality, should be considered an information channel. There should be some N independent terms along the banker yield, N the precision. The terms allocated so as to equalize the information flow for each bank loan. So, the steep portions of the curve will have more independent terms.
I would say to the Fed, target two year rates to be 1.5?do this by trading in one year notes. Leave the long stuff alone. But I just eyeball the Treasury curve from my Universal Economic Calculator.