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Robert Reich

Warning bells of deflation

Flat consumer prices, weekly earnings, and hours, coupled with increased economic pessimism, could be a recipe for deflation.

By Guest blogger / September 21, 2010

Labor Secretary Hilda Solis addresses the Congressional Hispanic Caucus Institute in Washington, Sept. 13. The Labor Department issued two reports on Friday, Sept. 17, that may indicate America is heading for deflation.

Charles Dharapak / AP

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Three economic reports today (Friday) that should sound warning bells about deflation.

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1. The Labor Department reports that consumer prices are essentially flat. Compared to August 2009, prices are up 1.1%. That’s only slightly lower than the 1.2% year-on-year rise in July. Excluding volatile food and energy, however, consumer prices in August were 0.9% higher than a year earlier. That’s below the Fed’s informal inflation target of between 1.5% and 2.0%.

2. In a separate report, the Labor Department said real average weekly earnings were unchanged in August from July, as both the average work week and hourly earnings were flat.

3. The Thomson Reuters/University of Michigan September reading of consumer confidence shows consumers more pessimistic in September than in August. In fact, consumer sentiment is the lowest since August 2009.

Put the three together and you have what could be a recipe for deflation: Flat consumer prices, weekly earnings, and hours, coupled with increased pessimism about where the economy is heading.

Consumers aren’t buying. They’re acting rationally. Their debt load is still huge, they’re worried about keeping their jobs, they know they have to tighten belts, and they’re justifiably worried about the future.

But for the nation as a whole, it spells even more trouble. If consumers hold back even more, prices will start dropping. When and if they do, consumers will hold back even more in anticipation of still lower prices. That means more layoffs and less hiring.

It’s a vicious cycle. And once deflation sets in, it’s hard to reverse. Just ask Japan.

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