That's probably the most important question in economics today.

This is more than a matter of competing narratives. The question goes to the heart of modern economics (the so-called Neo-Keynesian consensus) and the models used in economic forecasting.

In truth, it goes to the heart of economics generally and helps to explain why so many forecasts are so badly wrong.

The inflation narrative is straightforward. Inflation was gaining momentum from mid-2021 until it peaked at 40-year highs in June 2022. That peak was 9.1% inflation, a rate not seen since the early 1980s. At the same time unemployment was at lows of about 3.4%, a rate not seen since the late 1960s.

This combination of high inflation and low unemployment seemed to confirm the validity of the Phillips curve, which posits an inverse correlation between inflation and unemployment. When unemployment is low, inflation is high and vice versa.

The Case for Deflation

The deflation narrative, which includes disinflation, is also straightforward. By late 2021, the Federal Reserve became increasingly concerned about inflation and decided to act. The Fed began tightening monetary policy in early 2022, reducing the base money supply by not rolling over maturing mortgages and U.S. Treasury securities.

They tightened further with a policy of 10 straight interest rate hikes beginning last March and continuing until this May. (The Fed skipped a rate hike in June 2023 but is keeping the option to hike further on the table for now.) This took the Fed's policy rate to 5.25%, one of the fastest increases of that magnitude in Fed history.