Low Inflation Rate Raises Fears of Deeper Recession
The United States has attained what traditionally has been viewed as economic nirvana: inflation so low it’s almost invisible.
But trouble may be brewing. As inflation slides into the low single digits--Federal Reserve Board Chairman Alan Greenspan’s favorite indicator is 1.6%--some economists fear it will worsen the recession rather than provide a tonic.
Their concerns were underscored Thursday when the government reported that wholesale prices declined 0.6% last month, considerably more than expected. Their anxiety could be stoked again today if the closely watched report on consumer prices delivers a similar surprise.
“Disinflation is like truth. You don’t want to digest too much at one time,” said Robert J. Barbera, chief economist with Hoenig & Co., an investment firm in Rye Brook, N.Y. “A core inflation rate of 1% is, in the current environment, too much of good thing.”
Most economists don’t think the United States faces the risk of sustained, debilitating deflation in which prices fall month after month, consumers hoard cash, businesses go bust and unemployment soars.
But this is a different kind of recession, some economists contend, and it calls for a different view of inflation.
Even if inflation remains in the 1% to 3% range, which many would consider ideal under normal circumstances, the combination of softening prices and a retreating economy could lead to an increase in debt defaults and work force reductions, some analysts said.
Already, recessionary forces are damping demand for a wide range of goods and services, and businesses can’t count on rising prices to make up the difference.
“We’re already too low in my view,” said James W. Paulsen, chief investment officer with Wells Capital Management in Minneapolis. “If you’re a CEO and you make a mistake, you can’t raise your prices to get out of it. There’s no way to bail out.”
Brian S. Wesbury, chief economist with Chicago investment banking firm Griffin, Kubik, Stephens & Thompson, said, “The problem with zero inflation is that it’s a knife’s edge. Right now the risk of deflation is very real.”
When the economy is expanding at a healthy rate, of course, a low inflation rate is highly desirable. It makes it easier to make long-term financial plans, such as whether to buy a house, a car or a small business, when to have children, or where to send them to college.
“There’s a broad consensus that an optimal rate is one that is sufficiently low that inflation does not become a primary consideration when people are making decisions, whether it’s business investments or home purchases,” said Ken Matheny, senior economist with Macroeconomic Advisers, a St. Louis forecasting firm.
Recent declines in wholesale and consumer prices have been fueled in large part by falling energy prices.
Over the last year, the price of crude oil has fallen more than 40% and natural gas more than 60%. Since a large portion of energy purchases goes to overseas producers, any decline is a plus for the U.S. economy, even if it causes temporary deflation.
Goldman Sachs estimates that lower prices and consumption will generate a $40-billion windfall for U.S. consumers this winter. That’s about $400 per household, more than Americans pocketed from last summer’s tax rebates.
The extra discretionary cash will boost consumer spending by about 1% over 12 months, the firm projects.
“You’re looking at a big change that is adverse to the people that own energy and favorable to the people that buy energy,” said Princeton economist Alan S. Blinder, a former Federal Reserve vice chairman. “For the whole corporate sector, I don’t see this as a negative. It’s not good news if you’re Exxon.”
Several analysts noted that when volatile energy and food prices are excluded from the equation, wholesale prices actually increased 0.2% in November.
“Deflation? Yes, it’s a conceivable problem,” said Charles L. Schultze, senior fellow at Brookings Institution, who chaired the Council of Economic Advisors in the Carter administration. “But if I have to worry about what’s going on in the U.S. economy at the moment, I’ll put that sixth or seventh on my list.”
Jim Glassman, senior U.S. economist with J.P. Morgan & Co., said he doesn’t foresee serious problems as long as the inflation rate remains positive, a view that appears to be shared by the nation’s financial markets. Stock prices have rallied, the dollar is highly valued and bond traders appear more worried about future interest rate increases than falling inflation, he said.
