Why the prospect of deflation could pose a threat to US economy
WASHINGTON - The economic paralysis caused by the coronavirus led in April to the steepest month-to-month fall in U.S. consumer prices since the 2008 financial crisis - a 0.8% drop that was driven by a plunge in gasoline prices.
And excluding the normally volatile categories of food and energy, so-called core prices tumbled 0.4%, the government said in its monthly report on consumer inflation. That was the sharpest such drop on records dating to 1957.
The business shutdowns, reduced travel and shrunken consumer spending that the virus has caused have likely sent the U.S. economy into a severe recession. The resulting drop in economic activity is exerting a powerful downward force on prices throughout the economy.
Tuesday's report raises the prospect of deflation, a prolonged drop in prices and wages that typically makes people and companies reluctant to spend and can prolong a recession. Not since the Great Depression of the 1930s has deflation posed a serious economic threat in the United States.
“If deflation becomes embedded in the economy, it can be difficult to uproot,” said Gus Faucher, chief economist at PNC Financial Services.
Over the past 12 months, overall prices have risen a scant 0.3%, the smallest year-over-year increase since 2015. Core inflation has increased 1.4%, the lowest pace since 2011. With consumer prices falling, concerns have arisen that the United States might succumb to a debilitating bout of deflation for the first time in decades.
The dour indicator of consumer pricing and its potential lingering impact on the economy comes as the U.S. central bank leader called for more opening of federal coffers to help reduce the risk of lasting damage. Federal Reserve Chair Jerome Powell warned Wednesday of the threat of a prolonged recession resulting from the viral outbreak and urged Congress and the White House to act further to prevent long-lasting economic damage.
The Fed and Congress have taken far-reaching steps to try to counter what is likely to be a severe downturn resulting from the widespread shutdown of the U.S. economy. But Powell cautioned that numerous bankruptcies among small businesses and extended unemployment for many people remain a serious risk.
“We ought to do what we can to avoid these outcomes,” Powell said.
Additional rescue aid from government spending or tax policies, though costly, would be “worth it if it helps avoid long-term economic damage and leaves us with a stronger recovery,” he said.
Powell spoke a day after House Speaker Nancy Pelosi, a California Democrat, proposed a $3 trillion aid package that would direct money to state and local governments, households, and health-care workers. This money would come on top of roughly $3 trillion in earlier financial assistance that the government has provided. The Fed itself has also intervened by slashing interest rates to near zero and creating numerous emergency lending programs.
Yet Trump administration officials have said they want to first see how previous aid packages affect the economy. And Republican leaders in Congress have expressed skepticism about allowing significant more spending right now. Senate Majority Leader Mitch McConnell, a Kentucky Republican, said there is no “urgency” to act.
The fact that falling consumer prices tend to cause worry among economists and policymakers may strike many people as puzzling. Here are some questions and answers:
WHAT EXACTLY IS DEFLATION?
Deflation is a broad and prolonged decline in prices and wages and often in the value of homes or other assets. During deflationary periods, broad barometers like the Consumer Price Index that the government issued Tuesday will show consistent price changes below zero.
And for two months now, that is what the CPI has shown: The index fell 0.4% in March and 0.8% in April. The trend is likely to persist as the virus depresses economic growth and consumer spending and thereby exerts downward pressure on prices.
AREN'T FALLING PRICES GOOD? PEOPLE CAN BUY MORE THINGS WITH LESS MONEY, RIGHT?
It's true that households can make their paychecks go further when prices are flat or falling. And with tens of millions of people suddenly out of work, this means that at least their unemployment benefits will stretch further. The 20% drop in gasoline prices in April, for example, will provide a welcome benefit to motorists. All that said, economists fear that sustained price declines would hinder, not help, economic growth.
The main reason is that falling prices typically make consumers and businesses delay spending. Why buy now, after all, if you can purchase the products you want - from furniture and appliances to cars, boats and computer equipment - at even lower prices three or six months from now? Collectively, such delays slow consumer spending, which drives about 70% of U.S. economic activity. Consider the economy's 4.8% annual contraction during the January-March quarter. That quarterly decline, the worst since the 2008 financial crisis, was led by a broad pullback in consumer spending.