Economists Worrying About Deflation
The Associated Press
The Charleston Gazette
Friday 16 May 2003
WASHINGTON For American consumers, the prospect of falling prices sure sounds like a good thing. But a prolonged and widespread decline, with everything from real-estate values to incomes collapsing, would spell disaster for the U.S. economy.
Concerns among private economists about a rare and dangerous episode of deflation were heightened by a government report Thursday showing a record 1.9 percent drop in wholesale prices in April and a Federal Reserve warning last week about the possibility of a destabilizing fall in prices.
Although Fed Chairman Alan Greenspan and his colleagues indicated that the chance of deflation was remote, Fed policy-makers said it still represented a potential threat to the already weak economy, a concern that has thrust the matter into the national spotlight.
Deflation is like quicksand. We want to be 10,000 miles away from it, said Sung Won Sohn, chief economist at Wells Fargo. Once you get into deflation the consequences are so severe it is hard to get out, he added.
America s last serious case of deflation occurred during the Great Depression of the 1930s.
At such a time, prices are generally falling across the board for goods, services, stocks and real estate, economists said. Workers get socked with pay cuts and businesses watch their incomes and profits shrivel, making it harder for them to pay off debt.
Consumer behavior also changes. Shoppers seeing a steady stream of discounting put off making purchases to wait for even better deals later.
In the United States, where consumer spending accounts for two-thirds of all economic activity and is the main force keeping the economy going, such a change would seriously hurt the economy.
Business, meanwhile, would cope with such a situation by throttling back production and cutting jobs, wages and capital spending, providing another blow to the economy.
Economists view deflation as a far more serious threat than inflation because the Fed s primary tool for boosting economic activity a reduction in interest rates might have only a limited impact on the psyche of consumers and businesses once a deflationary spiral takes hold.
Japan, for instance, has been unable to get rid of long-standing deflation problem and turn around its economy despite having driven interest rates down to zero.
A key short-term interest rate controlled by the Fed, the federal funds rate, is already at a 41-year low of 1.25 percent. Fed policy-makers last week signaled they are prepared to cut that rate to ward off even the threat of deflation. Economists said that raised the odds of a rate cut at the Fed s next meeting on June 24-25.
The Fed can t lower interest rates below zero, but policy-makers say they can do other things to pump more money into the economy to fight deflation.
Economists also pointed out that a weaker U.S. dollar can help.
Neither the Fed nor economists want to see the United States, struggling for three years to overcome the bursting of the U.S. stock market bubble, follow Japan into a falling price spiral. Japan, where real estate prices collapsed in the late 1980s, has been mired in more than a decade of weak growth, compounded now by prolonged deflation.
Treasury Secretary John Snow said he saw little threat of deflation developing in the United States.