For Fed, a little inflation may be a good thing

By Jeannine Aversa
Associated Press / September 23, 2010

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WASHINGTON — It might seem like prices are rising wherever you look, from medical care to college tuition. Yet to the Federal Reserve, they might not be going up fast enough.

The Fed says a little more inflation might be just the thing to start a chain reaction that would ultimately create jobs — and avoid a spiral of falling prices that could damage the economy.

In a statement Tuesday, the Fed avoided directly mentioning the dreaded word “deflation,’’ but it signaled its concern that today’s very low inflation might lead to actual price drops.

The Fed, meeting for the last time before the midterm elections, said its measures show inflation is “somewhat below’’ desirable levels for the economy. That may sound strange, because inflation is often made out to be an economic evil.

And it can be, when it gets out of control. But its opposite can be even worse.

Once deflation takes hold, it can wreck an economy. Workers suffer pay cuts. Corporate profits shrivel. Stock values fall. People, businesses, and the government find it costlier to pare debt. Foreclosures and bankruptcies rise.

And people spend less, convinced that prices will fall even further if they just wait. That trend has already emerged in the housing market.

Spending by shoppers accounts for about 70 percent of US economic activity.

Overall consumer prices — excluding food and energy prices, which are volatile — inched up just 0.9 percent for the 12 months that ended in August. That matched a 44-year low, according to the government.

And it’s well below the Fed’s comfort zone for inflation, which ranges between 1.5 percent and 2 percent over a year.

The Fed’s statement Tuesday made clear that it’s prepared to intervene to prevent deflation. One way would be to make big purchases of government bonds to drive down long-term interest rates.

“The average person may be bewildered by the Fed’s concern about deflation,’’ said Allen Sinai, chief economist at Decision Economics. “But part of its job is to be educational. The Fed wants people to know it is not going to let this rare disease happen.’’

The last time the country endured a destabilizing case of deflation was during the Great Depression of the 1930s.

Japan is still fighting deflation years after its 1990s financial crisis, even as it has kept its key short-term interest rates near zero, as the Fed has for nearly two years. So far, the Fed’s ultra-low rates have failed to rejuvenate the economy.