Policy makers navigating the U.S. through the global credit crisis may have a new concern on the horizon for 2009: deflation.
The risk of deflation -- generally falling prices across the economy, beyond volatile energy and food costs -- remains slim. But the financial shock and a faltering economy can set the stage for a deflationary environment.
Federal Reserve officials view broad-based deflation as unlikely but possible........The economic slowdown and declining commodity prices have eased the nation's consumer inflation rate, which surged to 5.6% over the summer. Annual inflation in the U.S. is likely to turn negative for at least several months next year, on declining energy and food prices.
With the unemployment rate rising rapidly and capital markets in turmoil, "pretty much everything points toward deflation," said Paul Ashworth, chief U.S. economist at Capital Economics. "The only thing you can hope is that the prompt action of policy makers can maybe head this off first."
The Japanese economy in the 1990s and the U.S. during the 1930s illustrate how deflation can choke a weak economy and spiral out of control. A sagging economy exerts downward pressure on prices because of weak demand for labor and goods. Broad-based declines -- particularly in a credit crisis, which can push asset prices down sharply -- can also force down wages, preventing consumers and, therefore, companies from paying their debts. Falling prices also encourage businesses and consumers to save rather than spend, because money would be worth more after prices decline. The restrained spending, in turn, hurts the economy even more.....MORE
Slim and unlikely? From the Telegraph:
Britain faces deflation for first time since 1960
Britain will slump into deflation next year for the first time in half a century, experts have warned.
For the first time since 1960, the cost of living will start to shrink next year, in a worrying parallel of the Japanese "disease" of the 1990s, according to new research.The news comes amid growing speculation that the Bank of England will soon be forced to cut borrowing costs to 2pc or below, taking them to their lowest level since it was founded in 1694.
The Monetary Policy Committee last week unexpectedly cut rates by a half percentage point to 4.5pc in the face of the financial crisis. However, there is also growing evidence that inflation, which has risen above 5pc in recent months, is set for a dramatic fall. The Retail Price Index – the most comprehensive measure of UK high street prices, will drop at an almost unprecedented rate to -2pc by the second half of next year, according to new research from Fathom Consulting.
It said the fall was largely due to the drop in mortgage costs and house prices, which together form a large part of the RPI. However, lower food and energy prices would also play an important role. Since modern comparable records began in 1956, the RPI has dropped into negative territory only once, in the late 1950s and early 1960s, but it only dropped as far as a rate of -0.5pc.
For the first time since 1960, the cost of living will start to shrink next year, in a worrying parallel of the Japanese "disease" of the 1990s, according to new research.
The news comes amid growing speculation that the Bank of England will soon be forced to cut borrowing costs to 2pc or below, taking them to their lowest level since it was founded in 1694.
The Monetary Policy Committee last week unexpectedly cut rates by a half percentage point to 4.5pc in the face of the financial crisis. However, there is also growing evidence that inflation, which has risen above 5pc in recent months, is set for a dramatic fall. The Retail Price Index – the most comprehensive measure of UK high street prices, will drop at an almost unprecedented rate to -2pc by the second half of next year, according to new research from Fathom Consulting.
It said the fall was largely due to the drop in mortgage costs and house prices, which together form a large part of the RPI. However, lower food and energy prices would also play an important role. Since modern comparable records began in 1956, the RPI has dropped into negative territory only once, in the late 1950s and early 1960s, but it only dropped as far as a rate of -0.5pc....MORE
