Inflation

10 Pages 2383 Words

Alan Greenspan and his colleagues at the Federal Reserve have spent their professional lives fighting inflation. But in the fall of 1999, central bank officials gathered at a country inn in Woodstock, Vt., to talk about the opposite: What would they do if faced with deflation, or widespread falling prices, and they already had cut interest rates to zero?

Deflation is dangerous because it makes it hard to boost the economy by cutting interest rates, and because it makes debt, now at a postwar high in the U.S., harder to repay.

At Woodstock, researchers brainstormed about possible ways the Fed could spur spending, such as adding a magnetic strip to dollar bills that would cause their value to drop the longer they stayed in one's wallet.

At the time the chance of deflation in the U.S seemed remote. Inflation was low, but the economy was booming and the Fed had lifted short-term interest rates above 5%.

Today, deflation no longer seems so remote.

Prices of consumer goods, as opposed to services, are falling for the first time since 1960. By the Fed's preferred measure, overall inflation was just 1.8% in the year through August. Fed policy makers have cut short-term interest rates to a 41-year low of 1.75%, and investors expect them to cut rates again in coming months to as low as 1.25% -- perhaps starting at their meeting today.

The U.S. economy is struggling with the collapse of a gigantic stock mania. Sinking prices for telecom services, to name just one conspicuous example, are already making it harder for some businesses to support their heavy debts.

Overseas, Japan is in its fourth year of declining prices even with interest rates near zero, a result of a decade of economic stagnation that followed the bursting of its real-estate and stock bubble. China has experienced intermittent deflation since 1999 and a few economists think Germany may be close. The International Monetary Fund projects that inflation in indust...