Economy near the edge -- of deflation
Falling consumer prices beginning to worry economists
>>Costs for a broad array of products and services are headed south, ranging from new cars and computers to telephone calls and magazines. Some economists say that puts the nation perilously close to deflation -- a situation in which falling prices squeeze business profits, choking off new investment and pushing the economy back into recession.
"We're probably right at the threshold of deflation," said Joel Popkin, a Washington consultant who ran the Labor Department's inflation-monitoring program in the 1970s. "I've been watching prices for 35 years, and I never thought I'd see this."<<
Sam Zuckerman, Chronicle Economics Writer Saturday, May 17, 2003
The cost of a wide range of goods and services dropped in April, stoking fears that falling prices may be undermining the nation's economic growth.
The widely watched consumer price index fell 0.3 percent last month, following a 0.3 percent rise in March, the Labor Department reported Friday.
Falling prices can be devastating because profit-starved businesses would likely hold back on hiring and investment, touching off a vicious circle of economic contraction.
The April drop was due mainly to falling oil prices after the Iraq war. Taking out volatile food and energy costs, prices were unchanged for the second month in a row. On a year-over-year basis, the price index for items other than food and energy was up 1.5 percent, the slowest rate of increase in 37 years.
Costs for a broad array of products and services are headed south, ranging from new cars and computers to telephone calls and magazines. Some economists say that puts the nation perilously close to deflation -- a situation in which falling prices squeeze business profits, choking off new investment and pushing the economy back into recession.
"We're probably right at the threshold of deflation," said Joel Popkin, a Washington consultant who ran the Labor Department's inflation-monitoring program in the 1970s. "I've been watching prices for 35 years, and I never thought I'd see this."
The Federal Reserve has recently stepped up its warnings about deflation, declaring it is prepared to take strong measures to keep prices from falling. In congressional testimony late last month, Fed Chairman Alan Greenspan said any further drop in inflation would be "an unwelcome development."
CONSUMERS SKEPTICAL
The notion that goods and services are getting cheaper is one many consumers reject. They point to rising costs of insurance, college tuition and everyday items such as personal care products.
"If prices are falling, let us know where," said Oakland resident Angela Washington. "I haven't seen it." She noted that the cost of her favorite brand of lipstick had just gone up 50 cents to around $13.
Experts say consumers are partly right.
"In terms of the things you buy every day -- a cup of coffee, a haircut -- there's still quite a bit of inflation," said Irwin Kellner, an economist at Hofstra University in New York. "But those are dwarfed if the price of a car goes down $5,000."
Generally speaking, Kellner said, prices of a wide array of goods such as furniture, electronic items and clothing are falling, while the costs of many services are still rising.
Still, the pace at which service prices are increasing has slowed dramatically. The cost of medical care, for example, has been growing at a 2.2 percent annual rate so far this year, less than half the pace a year ago.
Economists say prices of many goods are dropping because of relentless global competition and production capacity in the world's factories that far exceeds total demand.
EFFECT OF DEFLATION
True deflation, in which a wide range of prices keep falling over a long period of time, is one of the worst things that can happen to an economy. Deflation hasn't been seen in the United States since the Great Depression, but it has kept Japan in or near recession for most of the past decade.
"With deflation, it's very difficult for an economy to grow," Popkin said.
When prices are falling, business profit margins narrow, making them reluctant to hire and spend. In addition, it's burdensome to borrow money for expansion because debts must be repaid with dollars that have become more valuable, not less.
When deflation hits, defensive attitudes and behaviors ripple through the economy as businesses spread the pain to their vendors.
For example, Florio is a popular eatery in San Francisco's Pacific Heights neighborhood. As business conditions turned down, the restaurant started offering a three-course fixed price dinner for between $25 and $29, significantly less than its average tab of $40 to $45. It also started serving less expensive wine marked up two or 2 1/2 times its cost compared to the three-times markup standard for wine.
To counter the squeeze on its profits, Florio has been seeking discounts from its suppliers. "We are very aggressive when it comes to finding the best price for the best quality," said John Castanon, the restaurant's manager.
For the Fed, these dynamics present knotty problems. When the economy gets too weak, the nation's central bank lowers interest rates to boost demand.
LOSING THE RATE-CUT OPTION
But the Fed's benchmark short-term rate is already at a four-decade low of 1.25 percent. The Fed can't push the level below zero. That means it has nearly run out of room for further rate cuts.
Officials of the central bank have been studying unconventional steps to take when the rate-cut option is played out. There is talk of buying corporate bonds or other assets to inject more cash into the economy. But no one knows how well these or other measures would work in an emergency.
"The Fed and other policymakers are getting nervous, " said Cary Leahey, an economist with Germany's Deutsche Bank in New York.
In effect, said Leahey, the Fed was too successful in its long fight to eliminate inflation. "There's an old saying: 'Be careful what you wish for,' " he said. "The Fed has gotten what it wished for."
sfgate.com |
