Disinflation Ahead for US Economy, But Not Deflation

AS the recession deepens and bank failures multiply, the financial community is increasingly worried about the threat of ``deflation'' - a sustained decline in the general price level accompanied by a contraction in money and credit. Powerful forces are indeed pressing toward ``disinflation'' - a much lower rate of inflation. Some prices have fallen substantially and credit difficulties are obviously widespread. However, deflation still appears improbable. Far from deflation, all major indicators of inflation accelerated in 1990, despite a December dip in producer prices.

On average, more prices went up than down last year. Even home prices - the most painful point of stress for most consumers - were higher on balance in 1990 than in 1989. Granted, home prices are down in some areas and the rate of increase has slowed almost everywhere else, the median sale price for existing homes still went up.

While the United States banking crisis is certainly serious, money and credit have continued to grow slowly. There is no comparison with the deflation of the 1930s. The money supply in the US fell by one-third from 1929 through 1933. Then, failing financial institutions triggered a cascading collapse in the general price level. Now, with federal banking regulators on full alert, there is little chance of a replay.

Nonetheless, itinerant soothsayers continue to wander around lower Manhattan speculating about deflation. This is irresponsible. If, in reaction, consumers were to sit back to wait for bigger and bigger bargains, they could be sadly disappointed. Were the Federal Reserve System so foolish as to take such maundering seriously, it might flood the economy with money. In that case, prospects for lower inflation would dim and interest rates would rise - a perverse and counterproductive result.

According to the McGraw-Hill Dictionary of Modern Economics, deflation is ``a fall in the general price level associated with a contraction of the supply of money and credit.'' Moreover, common sense would dictate that falling prices should persist over a period of time to qualify as a deflation. A transitory drop over a few months would not necessarily be deflation, any more than a similar increase would automatically represent inflation.

Semantics aside, every one of a half-dozen or more broad-based measures of the price level has accelerated during 1990 - with or without energy. As one example, the average monthly increase in the consumer price index excluding energy during the first 11 months of 1990 was at an annual rate of 5.3 percent, up from 4.6 percent for the full year 1989. Including energy, of course, the acceleration was much greater.

Meanwhile, money and credit have continued to grow, but at modest rates because of the Federal Reserve System's persistent policy of tight money. Equally important, the nation's financial system has not collapsed, despite the distress among savings and loans and banks. One comprehensive measure of the supply of money - including currency, checking accounts, and consumer thrift balances - rose more than 5 percent during 1990, well above its 3.7 percent gain in 1989.

Thus, on both criteria - prices and money - the economy has not entered a period of deflation, as that term is normally understood. Much slower rates of increase in prices are very likely. But even that development, long sought by the Federal Reserve and highly desirable for the nation, is still a forecast, not a fact.

It is true that a number of prices have fallen precipitously recently. The index of 23 basic raw material prices maintained by the Commodity Research Bureau dropped at an annual rate of 18 percent over the last three months. Empty, or even partially occupied, office buildings are a drag on the market all over the country. Suburban homes have come down substantially.

However, such changes are part of the ebb and flow of a free economy, not evidence of a ``new deflation.'' There are hundreds of thousands, if not millions, of prices in the US. At any time, some are always rising and some are always falling.

It will take time, hard work, and lots of cash to make US financial institutions profitable once again. There are plenty of unpaid invoices outstanding from the excesses of the 1980s. The cost will be substantial. Happily, that cost is not likely to include the wrenching social and political cost of deflation.