Congress Can Stave Off Damaging Deflation

Bloomberg Businessweek May 25, 2020 pp34-35 Economics “Deflation Stalks The U.S.” “Falling prices could become self-sustaining, prolonging the economic slump”

Total 12-month percentage change, in the Consumer Price Index (CPI), selected categories, not seasonally adjusted.

The Federal Reserve targets CPI at 2%. Without adjusting for seasonality, for the six months prior to March 2020 the average CPI has been close to the target of 2%. As charted above and detailed in the table, April’s CPI was 0.3% due to lower energy, apparel, transport and new vehicle prices while retail food prices increased to 4.1%-the highest in the last two years (reflects the surging demand at the retail level).

As it turns out modest inflation, as targeted by the Federal Reserve, is good as it enables healthier margins for businesses and reduces the relative impact of committed consumer debt like mortgages and other fixed-rate loans including student debt. Simply put, overall most prices reflect demand and available supply. If demand is too great, prices rise thereby reducing our buying power. If the economy heats up too much, then the Federal Reserve can raise interest rates forcing businesses to cut back on capital expenditures, materials and labor. Such an adjustment has the effect of reducing demand partly due to higher unemployment.

When CPI is trending lower, consumers eventually won’t see cost-of-living-adjustments (COLA) to wages and pensions. Consumers and businesses then don’t realize the benefits of modest inflation. Even worse and driving more deflation is a buyers response to falling prices. Once consumers and businesses realize prices are falling they delay buying “big ticket” items like capital equipment (businesses) and appliances-vehicles and -homes (Consumers). This downward pressure on CPI is known as deflation.

The toolkit to raise supplier prices and CPI are relatively limited. “Japan, which has struggled through repeated bouts of deflation since the 1990s has seen only limited success with negative rates. Over the past 25 years, its economy has averaged growth of less than 1% per year”. Knowing that moving interest rates lower is an ineffective economic stimulus, the Federal Government must stimulate the economy by implementing another stimulus package. Such an additional infusion will prop up unemployed workers, faltering businesses, state and municipal governments. Without such an action by congress, business and local governments will be forced to lay-off even more essential workers and other staff.

As “most economists see extended deflation as still avoidable” they are looking, at least, for prices to stabilize in the second half of 2020. Without a stimulus, they caution this might not happen regardless if there is or isn't a significant second wave of COVID-19. “In the view of many economists…the onus [is] on Congress to pass another stimulus…”