Saturday, September 25, 2010

Unusual worry for economy: Is inflation in U.S. too low?

WASHINGTON - It might seem like prices are rising wherever you look, from medical care to college tuition. Yet to the Federal Reserve, they might not be going up fast enough.

The Fed says a little more inflation might be just the thing to start a chain reaction that would ultimately create jobs - and avoid a spiral of falling prices that could damage the economy.

In a statement Tuesday, the Fed avoided directly mentioning the dreaded word "deflation." But it signaled its concern that today's very low inflation might lead to actual price drops.

The Fed, meeting for the last time before the midterm elections, said its measures show inflation is "somewhat below" desirable levels for the economy. That may sound strange, because inflation is often made out to be an economic evil.

And it can be, when it gets out of control. But its opposite can be even worse.

Once deflation takes hold, it can wreck an economy. Workers suffer pay cuts. Corporate profits shrivel. Stock values fall. People, businesses and the government find it costlier to pare debt. Foreclosures and bankruptcies rise.

And people spend less, convinced that prices will fall even further if they just wait. That trend has already emerged in the housing market. Many would-be buyers are standing on the sidelines, waiting for home prices to fall further.

Spending by shoppers accounts for about 70 percent of economic activity in the United States. A further drop in their spending could potentially throw the economy back into recession.

It's true that the costs of items like health care, education and transportation have surged. But the Fed studies a wide range of prices across the economy. Overall consumer prices - excluding food and energy prices, which are volatile - inched up just 0.9 percent for the 12 months that ended in August. That matched a 44-year low, according to the government.

And it's well below the Fed's comfort zone for inflation, which ranges between 1.5 percent and 2 percent over a year. The Fed would like to see inflation at least that high because it would show the economy is making a solid recovery. It would mean shoppers are confident enough to spend and businesses confident enough in customer demand to raise prices. Confident employers are more likely to create jobs.

Right now, prices are relatively low because the economy is still so weak. Companies can't raise prices because high unemployment and scant pay gains are making shoppers cautious. Companies have to resort to discounts and promotions to entice them.

The Fed's statement Tuesday made clear that it's prepared to intervene to prevent deflation. One way would be to make big purchases of government bonds to drive down long-term interest rates. That could help stimulate borrowing and spending.

"The average person may be bewildered by the Fed's concern about deflation," said Allen Sinai, chief economist at Decision Economics. "But part of its job is to be educational. The Fed wants people to know it is not going to let this rare disease happen."

And spreading more confidence among consumers and businesses would reduce the likelihood of a deflationary spiral, Sinai said.

by Jeannine Aversa Associated Press Sept. 23, 2010 12:00 AM

Unusual worry for economy: Is inflation in U.S. too low?

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