The Threat of Deflation
Hello, and welcome to “Business Unusual”. I’m Willow Bay. It destroyed careers, businesses and lives 70 years ago during the Great Depression. But is deflation really a threat in today’s economy? Should we really be worried about falling prices? Economics correspondent Kathleen Hays joins us from New York for a closer look. Kathleen, “deflation,” we are hearing that word a bit these days.
Well, I think to talk about it, Willow, first of all, we have to put our head in a different place, because if you go into the stores and find bargains, that’s a plus. But if prices start spiraling lower, that could be a symptom of deeper trouble in the economy.
For years, US consumers have been waiting for this day: modern technology and access to cheap foreign imports are whittling down prices on everything from clothing to computers, to shiny new cars. Problem is, if heading into deflation, where even falling prices can be too much of a good thing.
It usually doesn’t stop with the fact that you can buy things for less. There are companies who sell you these things, and this puts tremendous pressure on their operating margins and they have to cut cost. The risk is they would then have to turn to cut labor cost, which would be you, the consumers. SO you’d lose your job, or you’d lose your income.
So even the Federal Reserve is saying it’s a risk policymakers can’t ignore.
We have seen no evidence at this point that we are close to a dangerous point with respect to deflation. But, we are very consciously aware that we can not allow that to creep up on us unseen, so we put a lot of resources in examining and reevaluating this conclusion.
The last time the US experienced an outright and severe deflation was during the Great Depression of the 1930s. Prices fell more than 20 percent as bankruptcy soured, banks folded and jobs evaporated, pushing the nation’s unemployment rate up to 25 percent, and that’s the danger of deflation. When the value of your cash is actually falling, it creates the kind of fears that take dramatic moves by the government to get things rolling again.
Franklin D. Roosevelt
I can assure you, my friend, that it is safer to keep your money in a re-opened bank than it is to keep it under the mattress.
Fast forward to 2002, and prices are falling again. The good news is that this is mostly confined to basic commodities and manufactured goods, whose prices are being pressured lower by a tense global competition. Prices of services like health care, legal fees, and tuition cost are still rising. And they make up about 80% of the US economy. The bad news is that even prices of services could be vulnerable, if an external shock, like a war with Iraq, or another terrorist attack, pushed the US economy back into recession. And with the Core Rate of consumer price inflation down to an annual rate just over 2 percent, the economy is much closer to the point where deflation becomes a real possibility.
Just off the top of my head, I think of it as a 15,20 percent probability, which is a lot of different than I would have told you a year ago. I would have said 0.
That is the kind of thing that leads to deflation, but again, most people still put pretty low odds on it, thank goodness.