Is deflation heading America's way?

One-quarter of the world's population is experiencing deflation – prices of goods and services are falling, on average.

In Japan, the world's second-largest economy, prices are declining, as they are for China's 1.2 billion people and for residents of Hong Kong.

Is the United States next to be hit by deflation? Prices paid to US factories, farmers, and other producers already have fallen 1 percent in the past year. Consumer prices often follow producer prices.

Even so, most economists would probably agree with Mickey Levy, chief economist at the Banc of America Securities, in New York. "There is a very low probability of [deflation] unfolding," he says.

Mr. Levy argues that growth in the demand for goods and services by Americans still outstrips growth in the economy's ability to produce them.

That brings about "disinflation" – when the rate of inflation slows – but "based on sound economic fundamentals, [deflation] has no merit," maintains Levy.

Yet the Federal Reserve sees sufficient risk of deflation that in June it published a paper by four economists entitled, "Preventing Deflation: Lessons from Japan's Experience in the 1990s."

The lesson they draw is that when inflation and interest rates fall close to zero, and the risk of deflation is high, the government should take fiscal and monetary stimulus measures beyond conventional levels.

In theory, a government could stimulate inflation by mailing $1,000 checks to every household and have the central bank cover that expenditure by creating new money.

Fed Chairman Alan Greenspan cited the paper in testimony to Congress last month.

"To the last dying breath in his body, Greenspan will do everything he can to prevent deflation," says Paul Kasriel, an economist with Northern Trust Co. in Chicago.

Already, the Fed is pumping up the nation's money supply so that there's plenty of cash around to keep up purchasing and maintain prices. One measure of the money supply, known as M-2, has grown at a 7.8 percent annual rate in the past six months. "That's not low," says Mr. Kasriel.

What's so bad about falling prices? Doesn't everyone like bargains?

Economists don't, if deflation shrinks economic growth, boosting unemployment and hurting business. When prices drop, consumers may delay purchases to await still lower prices. Businesses have a harder time making profits.

While inflation shrinks the real cost of repaying debt, such as mortgage payments, deflation does the opposite. It makes it harder for debt-ridden consumers and businesses to service their loans.

Japan is a nation of creditors. So falling prices aren't so bad for people with fat savings accounts and even lots of cash. The purchasing power of that money increases over time. The Japanese, still prosperous, seem to tolerate the situation.

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