This article first appeared in the St. Louis Beacon, Nov. 24, 2008 - While falling gas prices and holiday retail bargains may be welcome news to cash-strapped consumers, economists have started tossing around a new term: deflation.
And they don't seem pleased about it.
Washington University economist Steve Fazzari explains that deflation -- the opposite of inflation -- has not been experienced in the United States since World War II.
"While lower inflation is usually considered a good thing, very few economists would argue that deflation is desirable,'' Fazzari said. "Yes, it's true that prices are lower, and it could have some positive effects. But the bigger concern is that especially in a system with weak credit markets if people's incomes are falling but their debts are not, it's harder to pay your debts. It makes default and bankruptcy even more likely. So it tends to be a magnifying factor.''
Fazzari explains that, historically, when an economy weakens and goes into recession, the rate of inflation slows.
"If we went in with 4 percent inflation, often you would see inflation slowing to 3 percent because of recession. And in some respects, that is considered a good thing -- not the recession -- but a positive side effect could be lower inflation and lower expectations coming out of the recession,'' he said.
But when the rate of inflation falls to zero, the threat becomes falling prices, falling wages and falling incomes.
By way of comparison, the decline in the rate of inflation was bigger during the early 1980s, but because that recession started with inflation in the double digits, deflation was never a serious concern, Fazzari said.
"It certainly was considered a possibility in 2002-2003 when the U.S. was having a hard time coming out of the 2001 recession. Recovery was extremely sluggish, inflation was very low, and some people said it could begin deflation again. But at no time since World War II, since the Great Depression, has the threat of deflation looked as severe as it does right now,'' he said.
Japan experienced modest deflation for a few years during the 1990s, which is considered the "lost decade" of Japanese economics, Fazzari added.
Though the economist acknowledges that deflation can be a scary prospect, he believes it is premature to use the term regarding the current economic crisis.
"One quarter of falling prices -- after there has been an unusual run-up in energy prices that has now turned the other way -- is not what I would call broad-based deflation,'' Fazzari said. "But I think considering the problems the economy is confronting right now, there is some worry that deflation could be the result, making things worse than they already are.''
Defined
Deflation: a general decline in prices, often caused by a reduction in the supply of money or credit. Deflation can be caused also by a decrease in government, personal or investment spending. The opposite of inflation, deflation has the side effect of increased unemployment since there is a lower level of demand in the economy, which can lead to an economic depression.
Source: www.Investopedia.com, a Forbes digital company
