Remember we talked about DEFLATION appearing by summer of 2003?
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Message 18347555
Deflation Boogeyman Haunts Fed
Wednesday May 7, 1:01 pm ET
By Andrea Hopkins
WASHINGTON (Reuters) - The fear of falling prices -- the boogeyman that has crippled Japan since the early 1990s -- has come to haunt the U.S. Federal Reserve.
After months of worry about sluggish growth and mounting job losses, the uncertainty of war and tepid business spending, the central bankers who steer the nation's monetary policy admitted concern about deflation.
The Fed signaled after its policysetting meeting on Tuesday in a brief but unusually complex statement that it stood ready to cut interest rates, if needed, to prevent an "unwelcome substantial fall in inflation."
It was the second such warning, but the first to appear in an FOMC (News - Websites)statement. Fed Chairman Alan Greenspan last week flagged the problem of slowing price rises when he testified before the House Financial Services Committee.
Few analysts believe the risk of falling prices in America is anywhere near that facing Japan, which has struggled for a decade with the self-reinforcing horror.
The Fed on Tuesday said low interest rates, falling oil prices, strong consumer confidence and strengthened debt and equity markets should foster improved growth "over time."
However, analysts cheered the Fed's shift in focus to -- and saber rattling against -- falling prices.
They said these warnings were not designed to frighten American investors but to reassure them the Fed is on the case and interest rates will stay low, allowing investors the lowest possible borrowing costs for long enough to get the recovery rolling properly.
"They're just saying that inflation is too low now, rather than too high," said Goldman Sachs chief economist Bill Dudley. "And that means we want growth, and we want growth to be strong enough to push inflation up and we're not tightening monetary policy for quite a long time."
WHITE HOUSE WATCHING
The White House on Wednesday joined the chorus of concern, saying it, too, would be watching prices.
"Administration officials are studying the Federal Reserve thinking on this matter," White House spokesman Ari Fleischer (News) said. "This is one of many areas in the economy that get reviewed on a regular basis."
According to the Fed's preferred measure of price rises, inflation rose at an annual rate of just 0.9 percent in the first three months of 2003, a sharp slowdown from the 1.5 percent increase in the fourth quarter of last year. Prices have not increased so anemically since the third quarter of 2001, when the attacks of Sept. 11 brought economic activity to a near standstill.
While lower prices may please shoppers, slowing price increases, or disinflation, can quickly turn to deflation -- when falling prices drive manufacturers to bankruptcy.
For the last year, factory owners and retailers have seen the prices they can charge for goods like clothing and cars sink steadily, while the cost of making them continues to rise.
With their profits under increasing pressure, businesses have laid off workers and curbed investment in plants and equipment -- the very sort of business spending central bankers have been hoping will boost overall economic growth.
"It's a vicious circle," said Sal Guatieri, senior economist at Bank of Montreal/Harris Bank. "People keep deferring their spending, which contributes to further economic weakness and further downward pressure on prices, and price expectations continue to fall. And when you believe that prices will continue to fall, you defer spending."
While the United States has not battled falling prices in a serious way since the Great Depression, the phenomenon has an all too frightening modern example.
"We already have a major industrial country battling a prolonged bout with deflation -- that's Japan. And it's an ugly situation," said Ken Mayland, president of Clearview Economics. |
