And the Fed will soon need to stem deflation

Federal Reserve Vice Chair Richard Clarida expressed confidence earlier this month that the US could avoid an outbreak of deflation. Can we avoid such an outcome as rising anecdotal evidence of wage cuts reveals the magnitude of the negative demand shock that has slammed through the US economy?
It was common early in the crisis to view the viral outbreak as a supply shock because, from the US perspective, it appeared to be largely impacting the flow of goods from China. This original view suggested an inflationary impact from the virus.
The demand-side impact, however, now clearly dominates the economic outlook. Shutting large portions of the economy resulted in a collapse in spending and surging unemployment. While aid in the form of forgivable loans to small- and medium-sized firms and enhanced unemployment benefits can help keep the basic framework of the economic system glued together, it won’t solve the fundamental problem that economic activity requires actual customers. No customers, no firms. No firms, no employment.
Not only do we have a collapse in demand, but the eventual rebound in activity is likely to be anemic, too. Yes, in comparison to the dismal second-quarter numbers, the third quarter will likely bounce as some activity returns. This bounce, however, will not be sufficient to lessen the gaping hole in demand left by the virus. Large portions of the economy, particularly those related to travel and tourism, will still be encumbered by social-distancing restrictions. People will be wary to return to the full range of activities they pursued prior to the virus. The result will be a protracted, substantial output gap that will weigh not only on inflation but inflation expectations as well. That shift in expectations will weigh on demand. For instance, a student recently asked me if I thought this was a crazy time to buy a car. I said it would be better to wait a few months for prices to come down instead.
What I find especially discouraging is the growing anecdotal evidence of widespread wage cuts. Such concerns also made their way into the Federal Reserve’s April Beige Book of economic conditions:
No District reported upward wage pressures. Most cited general wage softening and salary cuts except for high-demand sectors such as grocery stores that were awarding temporary “hardship” or “appreciation” pay increases. We typically think of wages as sticky on the downside, an outcome attributable to a social aversion to wage cuts. Employees don’t like wage cuts for obvious reasons, and employers worry that wage cuts will hurt morale and retention.
This downward nominal wage rigidity prevents real wages from falling quickly during a recession, driving unemployment higher than would be the case under more flexible wages. The slow adjustment of real wages helps explain the long period of sluggish wage growth after the last recession, or what former Federal Reserve Chair Janet Yellen described as “pent-up wage deflation.” Lower wages now are most certainly preferable to the alternative of high unemployment, as they spread the burden of the recession more broadly rather than concentrating it on the backs of a greater number of newly unemployed.
—Bloomberg