15886_9.12_000008141763XSmall

Deflation Worries

by Elaine Schwartz    •    Sep 13, 2010    •    265 Views    •    TIME TO READ: 1 minute

We have something else to worry about: deflation.

If you had $100 in 2000, you would need $126.60 in 2010 to make the same kinds of purchases. Called inflation, prices tend to go up each year. Most consumers and businesses are happy with a little inflation, maybe 2% annually.  

Recently though, the inflation rate has been sinking which means that prices are rising more slowly. Then, when prices actually decline, as they did during April, May, and June, we have deflation. As you might expect, businesses respond poorly to falling prices. Predicting lower profits, they postpone expansion, lay off workers, and decrease wages. At .3%, the July inflation rate was slightly up again. 

During the Great Depression, deflation was a serious problem. Between the fall of 1929 and 1933, prices dropped almost 13%. An expert on the 1930s, our Fed Chair Ben Bernanke has said that we will never let that happen again. But others wonder whether we have sufficient economic knowledge to know what to do.

How would deflation affect you? Will you spend more or less if you expect prices to fall? Will you borrow money? 

The Economic Lesson 

Inflation has 3 basic causes: 1) Demand pulls prices up because too many buyers are chasing too few goods. 2) Costs push prices up because land, labor or capital becomes more expensive. 3) Prices generally can rise when one group with monopoly power raises the price of an important commodity such as oil.

The basic cause of deflation is a severe plunge in spending from consumers, businesses, and/or government. In response, to attract buyers, producers lower their prices and a deflation spiral can begin.

« »