Consumers might welcome the prospect of falling prices. But widespread price declines would actually accelerate the economic downturn - and it turns out that fear of possible deflation was one reason the Federal Reserve cut interest rates to near zero last month.
According to minutes released yesterday of the December Fed meeting at which governors made the historic decision to slash interest rates to less than 0.25 percent, it was fear of deeper economic catastrophe that persuaded them to open the monetary spigot as wide as they could go in an effort to keep the failing economy from running completely aground.
"The overwhelming message gleaned from the minutes of the meeting is one of fear - fear of a deep recession and fear of a debilitating deflationary spiral that would capsize a debt-laden economy," said Joshua Shapiro, chief U.S. economist at MFR Inc., an economic forecasting firm in New York.
In their meeting last month, Fed governors expressed concern about "prolonged recession," although "that was not judged to be the most likely outcome," the minutes said. The consensus was that the economy would continue to contract into the middle of 2009 before beginning a slow turn-around, but they could not be confident of that prediction.
The specter of deflation haunted the 11-page document. Fed governors appeared to go out of their way to avoid the word, referring instead to "disinflationary dynamics" and inflation hitting "uncomfortably low levels."
"I don't know why they are so skittish when it's very clear that that is what they are talking about," said Gus Faucher, U.S. economist at Moody's Economy.com.
Some price declines can be good news for consumers in the short run. But if consumers and businesses with cash to spend start putting off purchases, hoping for further price declines, unemployment can accelerate not only because of declining demand but because, with prices falling, each remaining employee on the payroll becomes more costly to the employer.