What is the inflation outlook and deflation risk described?

• A. Inflation is forecasted to increase; deflation risk is low given low unemployment and potential policy responses.
• B. Deflation is likely due to weak demand.
• C. Inflation will be negative due to reduced money supply.
• D. Inflation will be unchanged regardless of policy.

Answer: (A)

When unemployment is low, demand for goods and services tends to be solid, and employers face tighter labor markets. That combination puts upward pressure on prices: firms may raise wages and pass higher costs onto consumers, and overall inflation tends to rise. Deflation, which is falling prices, is unlikely in that environment because weak demand isn’t what’s driving prices down. Policymakers have room to respond to rising inflation if needed—central banks can tighten monetary policy or governments can adjust fiscal policy to cool demand—so the risk of deflation remains low. In short, the likely scenario is a higher inflation outlook with deflation risk staying subdued because the economy is operating with strong demand and available policy tools.