Falling Prices Raise a New Fear: Deflation

By Steven Mufson and Michael S. Rosenwald
Washington Post Staff Writers
Friday, November 21, 2008

With the stock market crumbling and the economy shrinking, a whiff of deflation is in the air.

Oil prices yesterday slid below $50 a barrel to the lowest level since May 2005; stores are advertising sales on the eve of what should be peak holiday shopping season; and worldwide demand for items as varied as steel, petrochemicals and clothing plunged in October.

This week's news of a drop in consumer prices may sound on the surface like a good deal for financially strapped U.S. households. But economists warn that sustained deflation -- a period of falling overall prices -- would deepen the nation's economic troubles. Such a period would make it harder for people to repay debts and would prompt consumers to delay purchases in anticipation of lower prices and harder times.

"Everyone is having these huge sales, and consumers know if they wait longer, the chances of them not having a good selection is fairly small and the chances are that the prices will be lower," said Charles McMillion, an economist who runs MBG Information Services. "So why buy today? This is exactly why economists are always scared to death of deflation."

Other economists cautioned that one month's swoon in prices -- concentrated in areas linked to plunging energy prices -- was not cause for alarm and that the Federal Reserve possessed the weapons needed to combat falling prices.

The mere specter of a prolonged deflationary period, which hasn't happened in the United States since the Great Depression, is likely to steer Fed policy toward lower interest rates in the coming weeks. Fed Chairman Ben S. Bernanke warned about the dangers of deflation in 2002 when he was a Fed member and Alan Greenspan was chairman.

Ed Yardeni, a financial strategist and head of Yardeni Research, predicted that the Fed will move soon to force interest rates down and make it cheaper to borrow money to buy homes and finance other purchases, thus jump-starting the economy. "How do I know all this?" Yardeni said in a report this week. "Ben told me. He told everyone. He said he would do this under certain dire circumstances, which are rapidly unfolding right at this time."

But deflation could make borrowing unattractive for companies even if lending rates hit zero. Executives would not want to take on debt while prices and profits are falling.

The Labor Department's consumer-price figures for October, released Wednesday, showed the steepest drop since publication of figures began in 1947 and added to the anxiety in markets this week. And retailers are feeling the pinch.

Apparel makers have been hit hard. The recent consumer price index report showed that apparel prices fell 1 percent last month, the latest in a long history of problems for the industry. McMillion said apparel prices have been under severe pressure for 15 years as lower-cost imports have entered the market.

"Now, in addition to facing very low-priced imports, they are also facing a sharp cutback in demand," he said.

Retail prices for apparel -- even without adjusting for inflation -- were lower last month than in 1989. Overall consumer prices are up 76 percent in the same time.

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