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Low inflation's ugly side? Weak economy

Grind on the economy

Why is very low inflation bad for the economy? Isn't it helpful when prices stay low? Not when they barely budge. Here are some reasons:

• When prices barely move, many people postpone purchases. Why rush, if the same price — or lower — will be available in six months? Collectively, these delays slow consumer spending, the economy's main fuel.

• Too-low inflation raises the prospect of deflation — a broad decline in prices, pay and the value of stocks, homes or other assets. Deflation can further restrain spending and even tip an economy into recession.

• Retailers engage in harmful price competition. Big chains such as Wal-Mart, Best Buy and Bed, Bath & Beyond, for example, fought a brutal price war during the past holiday shopping season. Thirty-three retail chains cut their profit estimates for the final months of 2013, according to RetailMetrics LLC.

• Low inflation leads many businesses to hoard cash. Higher inflation, by contrast, would erode the cash's value. So businesses would be more inclined to spend — to hire or buy equipment.

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By Christopher S. Rugaber
Wednesday, Feb. 19, 2014, 9:06 p.m.
 

WASHINGTON — Since the Great Recession ended 4½ years ago, Americans have struggled with high unemployment, static pay and a slow economy. Yet they've had one thing in their favor: low inflation.

Well, hold the applause.

It might be unfathomable to people who bear scars from the double-digit inflation of the 1970s, but what the global economy could use right now is a dose of higher prices.

Overall prices are barely budging because the economy is still weak. And the reverse may be true, too: Super-low inflation has probably slowed growth from the United States to Japan to Europe. It's why the world's central banks would like prices to rise.

Most people aren't likely to work up much anxiety about low inflation. After all, the benefits can be great. Cellphone service has gotten cheaper. Breakfast cereal prices have dropped the past two years. TV prices have plummeted 29 percent since 2012. Last year, overall prices inched up 1.1 percent, according to the Federal Reserve's preferred gauge.

On Wednesday, the government said its producer price index, which tracks prices before they reach consumers, had risen 1.2 percent during the past 12 months.

Yet Ben Bernanke, the just-departed Fed chairman, has said policymakers worry as much when inflation is too low as when it's too high.

What's wrong with very low inflation?

Lots. When prices barely move, many people postpone purchases. Why rush, if the same price — or lower — will be available in six months? Collectively, these delays slow consumer spending, the economy's main fuel.

Too-low inflation raises the prospect of something worse: deflation — a broad decline in prices, pay and the value of stocks, homes or other assets. Deflation can further restrain spending and even tip an economy into recession.

Just ask the Japanese. Japan has been stuck in a deflationary trap for most of two decades. Its economy has barely grown. Fears have spiked that Europe might be next.

For now, prices in Europe are ticking up — barely. Inflation in the 18 nations that use the euro rose 0.7 percent in January from a year earlier. In Japan, consumer prices rose 0.4 percent for 2013.

So why is inflation so low across the developed world?

Blame a persistently subpar economy and a tough job market. When good jobs are scarce, businesses can hold down pay and prices. Companies can cheaply produce enough to meet demand.

“Prices have only gone down because nobody has any money to buy stuff,” said Antonio Duarte, a retired postal worker in Lisbon, Portugal, who favors discount stores.

A more fundamental factor is at work, too: People believe inflation will stay low. And inflation expectations can be self-fulfilling. Suppose a company expects to pay 3 percent more for salary and materials next year.

It will then raise its own prices 3 percent. The company's expectations would help produce 3 percent inflation.

Ask people if they're enjoying low inflation, and you may encounter puzzlement. Many of us don't feel it. One reason: Apart from the government's broad inflation gauges, many items have gotten much costlier during the past five or 10 years.

Although gasoline prices, for example, have risen just 1 percent in two years — a big reason overall inflation is low — gas is nearly 14 percent costlier than before the recession.

Although health care costs have long risen faster than overall inflation and college tuition has soared 76 percent in 10 years, stable or falling prices for many other items have offset those trends.

Low inflation helps when pay increases are weak. Consumers can stretch their dollars, yen and euros. In hard-hit European economies, such as Greece and Portugal, prices have fallen in the past year.

Ace Hardware CEO John Venhuizen said his company paid less to manufacturers for products it sells in 2013 than in 2012. That's helped offset other rising costs, such as health care.

“We are delighted,” Venhuizen says. “There's far less price pressure than I would have anticipated five years ago.”

But if retailers could raise prices, say, 3 percent or 4 percent, the extra revenue would allow them to pay employees more. And they wouldn't have to rely strictly on cost cuts to deliver profits.

Other businesses might also spend more. American companies are sitting on nearly $2 trillion in cash, according to the Fed. Jared Bernstein, an economist at the Center on Budget and Policy Priorities, notes that low inflation leads many businesses to hoard cash. Higher inflation, by contrast, would erode the cash's value. So businesses would be more inclined to spend — to hire or buy equipment.

Higher inflation would even make it easier for Americans to manage their debts. Laurence Ball, an economics professor at Johns Hopkins, noted that many car buyers have loans with rates of 2 percent or less. If inflation were 3 percent or more, pay would likely rise. The car loans would become cheaper to pay off.

Many economists have long feared that the Fed's efforts to stimulate growth would ignite inflation. Since 2008, the Fed has bought more than $3 trillion in bonds to try to keep loan rates low to encourage spending.

Yet to the surprise of many, all the money the Fed has pumped out hasn't caused prices to jump.

“It's a bit of a riddle,” says Richard Fisher, president of the Federal Reserve Bank of Dallas.

Most economists foresee inflation remaining low for at least two more years. Fed policymakers have forecast that inflation will be just 1.7 percent to 2 percent in 2016.

They'd be happy to be wrong. An uptick in inflation “is a sign that growth is happening,” says Alberto Cavallo, an economics professor at MIT.

Christopher S. Rugaber covers employment and the economy for The Associated Press.

 

 
 


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