Global deflation risk grows
October saw one of only seven monthly drops in the core Consumer Price Index since 1947.
(Page 2 of 2)
Moreover, if deflation becomes a broad-based trend that consumers expect to see in everyday goods, they may delay purchases in the hope of getting an even better price later. Similarly, life becomes harder for borrowers – whether it's a family buying a home or a business building a factory. The burden of the debt effectively grows larger over time, since the amount owed is not adjusting downward like other prices.Skip to next paragraph
Subscribe Today to the Monitor
"Deflation, like runaway inflation, can be self-perpetuating insofar as consumers defer expenditures," David Rosenberg, Merrill Lynch's chief US economist, warned in a report to clients last month. "The pricing backdrop is 'deflationary' today even though consumer prices have yet to deflate on a year-over-year basis."
He pointed to several ways in which deflation is now at work – some of them not in consumer prices but in forces that may affect those prices:
•Asset values are deflating, with US home values down 16 percent in a year and stock shares down about 40 percent – for a combined loss of $11 trillion in wealth. (In the CPI, the cost of shelter is computed using a "rental equivalent" formula that ignores the ups and downs of home prices.)
•After years of households building up heavy debts, the volume of consumer credit is declining significantly for the first time since the early 1990s.
•The job market is symbolically a "deflating" force, with fewer jobs translating into less income for consumers.
Such trends, economists say, means that inflation has ceased to be much of a near-term concern, despite the extraordinary interest-rate cuts and special lending provisions by the Federal Reserve and other central banks.
The current risk of deflation could be amplified by the global nature of the current crisis, which now encompasses many nations. Global commodity prices have been falling fast.
For all the comparisons to the 1930s, the current cycle hasn't approached anything like the Depression, when prices plunged for several years.
Mr. Rosenberg forecasts that modest year-over-year declines in US prices will be visible for much of 2009.
Many economists expect that inflation will be minimal but won't turn negative for 2009 as a whole.
"We believe that this inflation plunge will be temporary, and inflation will make a comeback as soon as 2010," economists at Morgan Stanley wrote last week. Still, they warned of the near-term risk that policies to counter a recession "may not find traction as early or by as much as we think."