The trouble with falling prices:
While lower prices can stimulate spending, if consumers threatened by job and salary cutbacks hold on to their money, more price slashing and layoffs can result.
By Marilyn Geewax
Washington Staff
Sunday, December 9, 2001
WASHINGTON -- This holiday season, Americans are scooping up computers, clothes, toys and other gifts at deeply discounted prices. Major retailers started slashing prices even before Thanksgiving, marking down many goods by 30 percent or more.
Central Texas drivers can buy gas for as little as 91 cents a gallon. Everything from furniture to jewelry seems to be on sale.
But while the bargains may cheer shoppers, some economists say the shrinking price tags may be a danger sign that deflation is taking hold.
Deflation is more than a temporary bout of price cutting. It's an extended decline in prices across the board.
When prices fall too far for too long, corporate profits erode, and businesses cut jobs and salaries. Frightened consumers hold on to their money, forcing prices down again in an insidious spiral that leads to further layoffs.
The signs that it may be emerging:
In October, the Consumer Price Index slid 0.3 percent. Import prices have fallen in seven of the past 10 months. In the commodity markets, copper prices in November were down 21 percent from a year earlier, and oil prices have fallen dramatically in recent months.
Deflation is "a creeping infection that moves from sector to sector in the economy," said Donald Luskin, chief investment officer for Trend Macrolytics, a California consulting firm.
The "infection" already has sickened many industries, sending prices to painfully low levels and squeezing profits. "Deflation has been very cruel to farmers and very bad for the steel, copper and other commodity businesses," Luskin said.
Most mainstream economists say they do not see a deflationary cycle taking hold outside a relatively small number of industries -- yet.
"We don't have deflation. We're not there now," said Janet Yellen, economics professor at the University of California at Berkeley and former chair of President Clinton's Council of Economic Advisers. "But we shouldn't be too complacent when we see conditions like these. It's a risk for some time in the future."
Whether a deflationary spiral actually arrives depends upon how quickly the U.S. economy springs back from the current recession, said Alan Blinder, an economics professor at Princeton University and former vice chairman of the Federal Reserve Board.
"Deflation is tied up with the question of how bad this slump is going to be," Blinder said. "If it gets much worse, then deflation will become a concern."
If a deflationary spiral were to take hold, Americans could find themselves in a very unfamiliar environment.
Elderly Americans who survived the Great Depression of the 1930s know how it felt to watch wages and prices fall dramatically. They knew the agony of taking out a loan for a house or other expensive item, only to watch the price drop while they struggled to make payments with a shrinking paycheck. The experience left many Americans of that generation with a lifelong aversion to debt.
But inflation shaped the outlook of the generations born after World War II. During the 1970s and early 1980s, when prices were jumping as much as 13 percent a year, consumers adopted a "buy now" lifestyle.
"The best thing you could do was to borrow up to your eyeballs to buy the most expensive house you could possibly get," economist Luskin said. "Then the house would appreciate, and you could pay back the loan in worth-less dollars."
Although inflation can erode savings, economists say it suits the American temperament better than deflation. The certainty that prices will be higher tomorrow can justify the urge to go on a shopping spree today.
Inflation also helped business owners report increasing sales revenue year after year, and allowed them to hand out pay raises.
But price hikes have slowed in recent years for many reasons, including greater productivity, cheaper foreign labor, tougher competition and bigger economies of scale. Some believe the Federal Reserve's monetary policy is a factor.
Now a new element is adding to the downward pressure on prices: shrinking demand for goods. The Commerce Department said last month that from July through September, the U.S. economy was contracting at an annual rate of 1.1 percent, the weakest performance in a decade. That came after the economy grew by just 0.3 percent rate in the preceding quarter.
As recently as this past summer, many leading economists were still focusing on the risks posed by inflation. They feared that the Bush administration's tax cuts, combined with the Federal Reserve's aggressive interest-rate cuts, would overstimulate the U.S. economy in 2002.
In the scenario they envisioned back in August, the economy would suddenly ignite early next year, creating such demand for workers and materials that wages and prices would shoot up. They noted that prices of health care, college tuition and rent already have been rising sharply.
But since the terrorist attacks of Sept. 11, worries about inflation have eased dramatically. The Federal Reserve, always on guard against inflation, has become so unconcerned about overstimulating the economy that it has cut interest rates three times since the attacks.
Most economists predict the Fed will continue cutting, most likely knocking another quarter-point from short-term interest rates at its Tuesday meeting. It already has pushed its benchmark federal funds rate down to 2 percent, a level not seen since the early 1960s.
Last month, the National Bureau of Economic Research declared that the U.S. economy has been in recession since March. The rest of the world economy has been slowing too, reducing demand for goods and putting more downward pressure on prices.
Allen Sinai, chief global economist for Decision Economics Inc., a consulting firm, said that if the global economy continues to unravel, "there is some deflation risk."
But more likely, the falling commodity prices will help spark a rebound before a fierce downward spiral can take hold, Sinai said. That's because "crude oil and energy price reductions are actually very positive for consumers and many businesses."
If Americans spend less to heat their homes and drive their cars, they will have more money left over to spend on other purchases, he said. That renewed consumer spending could spark the demand needed to send prices back up.
Allan Meltzer, an economics professor at Carnegie Mellon University, agreed that today's low prices are not so much a problem for businesses as an opportunity for sparking growth. "With the costs of heating and driving coming down, it's like getting a tax reduction," he said. "That's a good thing."
Once consumers realize how much money they are saving, Meltzer said, they will start spending and trigger a vigorous rebound. "The problem in a year or so will be inflation," he said.
Marilyn Geewax's e-mail address is marilyng@coxnews.com
What the terms mean
Deflation: The simultaneous fall of prices for a broad range of goods and services. While in the short term, it's good for those who have money to spend, over the longer term, it undercuts profits and leads to layoffs and depresses spending, which leads to more job cuts.
Inflation: The widespread increase of prices, usually accompanied by rising interest rates as the government tries to cool down an overheated economy. Inflation undermines household spending power and makes loans more expensive, for consumers and businesses.
Recession: The downside of the business cycle, a recession is signaled by falling production, prices and personal income and and rising unemployment.
Depression: The rock bottom of the business cycle, when unemployment is highest, and prices and public confidence in the economy are at their lowest. The last worldwide depression was in the 1930s |
