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US keeps deflation at bay, for now

Surveys suggest that Americans figure inflation is running about 3 to 4 percent nowadays. Actually, the rate is more like 1.5 to 2 percent.

And "it could get precariously close to zero over this coming year," predicts Robert Gay, an economist with Commerzbank Securities in New York.

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But deflation - a widespread, prolonged, and debilitating fall in prices - is not yet in the cards, maintains Mr. Gay. Some years ago he worked with "inflation models" as a senior economist at the Federal Reserve headquarters in Washington.

Fed Chairman Alan Greenspan agrees. In testimony to a congressional panel last Wednesday, he said deflation is not "an imminent, dangerous threat to the United States."

The cagey central banker added, though, that the threat of deflation, though minor, "is sufficiently large that it does require very close scrutiny and maybe, maybe, action" by the Fed.

What makes Mr. Greenspan cautious is the experience of Japan. Since the early 1990s, the island nation has been caught in a prolonged period of economic weakness. The Bank of Japan has pushed interest rates to essentially zero, yet it has not yet been able to stop deflation and return the economy to a sizzling pace.

"The notion of deflation just never entered our minds until the Japanese demonstrated to us otherwise," Greenspan said.

The basic concern is that with deflation, consumers and businesses have a motive to delay their purchases, awaiting lower prices. That slows sales. "It becomes a vicious circle," says Stuart Hoffman, chief economist for PNC Financial Services Group, Pittsburgh.

Gay's work with models indicates that today's inflation rate reflects how much slack there was in the economy a year ago. "Disinflation [a declining inflation rate] has a certain momentum to it that is hard to overcome," he says.

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At the moment, the economy is not running at its potential speed, with surplus capacity in business and rising unemployment. So inflation should be running soon at even a lower rate.

Despite a robust recovery from a recession, prices in the US were falling from mid-1954 into 1955, for example.

Ever since last fall, the Fed has argued that it has ample monetary tools to stop deflation. "Under a paper-money system, a determined government can always generate higher spending, and hence positive inflation," Fed Governor Ben Bernanke said then.

If the Fed pushed short-term interest rates down from the current 41-year low of 1.25 percent to zero, it could still put more money into circulation to stop deflation by buying Treasury bonds at attractive prices from institutional or individual owners.

Presumably, at some point consumers and businesses get so much cash in their pockets that they start spending it, boosting the economy.

The Bank of Japan has bought government bonds in an effort to revive Japan's economy. But critics say it hasn't bought enough to do the trick. And though taking other steps to loosen monetary policy slightly last week, Bank of Japan policymakers did not decide to buy more bonds.

Japan's problem is that its government has wasted money on public-works programs and rescues of failing banks that its deficits greatly swelled government debt, says Gay. The central bank couldn't buy it all up.

The US, he argues, has a more flexible, self-corrective economy that tackles corporate malfeasance and allows firms to go bankrupt, and thus should be more resistant to deflation.

Others say the weak economy and the burst stock-market bubble will push the US into deflation.


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