Lower inflation welcome news today but may mean big problems ahead
The nation’s core inflation rate last month grew at the slowest pace in 44 years, offering good news for shoppers at the checkout counter and a bit more breathing room for policymakers who worry that massive government efforts to spur the economy could trigger higher prices.
But despite these and other short-term benefits, Wednesday’s inflation report raised larger fears that the United States — and the global economy — may be sliding closer to a deflationary spiral that could undermine recovery from the recession.
Deflation occurs when consumer prices are falling. Although that might sound like a good thing, it has a powerful tendency to discourage spending, dampen business expansion and forestall new hiring.
And deflationary spirals can be hard to escape from once they take hold.
“It’s definitely a serious threat,” said Paul Ashworth, senior U.S. economist at Capital Economics in Toronto. “Once falling prices get into the psyche of the people, they tend to delay their spending, and that has knock-on effects on the economy.”
The Bureau of Labor Statistics’ report showed that consumer prices in April declined 0.1% from March largely because of a large drop in oil costs.
But the core inflation rate, which the Federal Reserve and other policymakers watch more closely because it excludes volatile energy and food prices, was flat in April and up just 0.9% from a year ago — the smallest increase since 1966 and the fourth straight month of declining core inflation.
Although consumer spending has picked up in recent months, the latest inflation figures reflected continuing weakness in the housing market and stagnant wages. Both have sapped the buying power of consumers, prompting retailers to slash prices to attract shoppers.
The Fed, in minutes of its most recent meeting released Wednesday, also expressed some concern about where inflation was heading.
Even as Fed officials raised their outlook for economic and employment growth, the minutes said they expected inflation to be “somewhat below rates that policymakers considered to be consistent over the longer run with the Federal Reserve’s dual mandate” of maximizing employment and price stability.
And that late April meeting came as the Greek debt crisis was just emerging as a threat to the whole European economy and before it began to shake the financial markets in the U.S., which Fed members said could stall the recovery in the United States.
If the U.S. economy were to weaken because of the events in Europe, that would put further downward pressures on inflation, said Alan Levenson, chief economist at mutual fund giant T. Rowe Price in Baltimore. Already, “inflation is too low for comfort,” he said.
The primary factor in April’s decline was a sharp drop in housing costs, including lower rents and prices for home furnishings. In the face of an uncertain recovery, high unemployment and wary consumers, most producers and retailers also have had little ability to raise prices on their customers.
Consumers in April saw a 0.9% decline in apparel prices from a year ago, the government said, and prices of electronics such as personal computers fell more sharply over the year.
Ultra-low and slowing inflation may be good in the short term, making goods and services cheaper for consumers. The latest report also reinforces the belief among analysts that the Fed will keep its benchmark short-term interest rates at near-zero levels for the rest of this year and possibly well into 2011.
The Fed’s record low rates since December 2008 and its massive injection of cash into the financial system during the recession had raised concerns of stoking inflation in the long term. But Fed policymakers, in their late April meeting, said they expected inflation to “remain subdued” through 2012.
“It’s good in the sense that the Fed obviously has room to hold a lot longer” on interest rates, said Joseph Brusuelas, a former Moody’s Economy.com analyst who runs Brusuelas Analytics in Stamford, Conn.
As recently as two weeks ago, he said, some analysts were projecting that the Fed would start raising rates late this year.
Brusuelas called the new inflation report “a yellow flag. He noted that so far there were few signs that consumers were expecting the inflation rate to fall in the coming months. But he added: “The risk is decisively tilting to deflation.”
More to Read
