Nov. 24 (Bloomberg) -- Given all the real problems facing the U.S. economy, dragging out the remote danger of deflation is foolish. It's just short of fear-mongering.

Yes, this is the worst financial crisis since the Great Depression, when consumer prices fell by one-fourth. Yet the economy, weak as its current prospects may be, bears little resemblance to that of the early 1930s.

In his radio address on Saturday, President-elect Barack Obama promised a massive stimulus package of tax cuts and spending increases to stimulate growth. Yesterday, Democratic congressional leaders said a program worth several hundred billion dollars would be ready for passage on Inauguration Day, Jan. 20. That's exactly what the economy needs at this point, and the promises ought to defuse the deflation scare.

Warnings about deflation increased after the Labor Department reported on Nov. 19 that consumer prices fell 1 percent in October. That was the largest monthly decline since seasonally adjusted figures began being published in 1947.

A close look shows the decline, while noteworthy, didn't signal that deflation lurks around the corner. Core prices, which exclude food and energy, dipped only 0.1 percent.

Most of the decline in the overall index was the result of the accelerating drop in energy prices, which fell 8.6 percent, the fourth consecutive monthly decrease. This is part of a broad contraction in commodity prices, a reversal of a huge run-up that peaked in July.

While there will be more bank failures, they won't be widespread. And with accounts federally insured, depositors aren't going to see their money vanish, as happened in the Depression.

No Wage Collapse

Nor is there any sign whatsoever that wages will collapse, as they did when unemployment soared to 25 percent in 1933. Pay is likely to increase more slowly in coming months, as it usually does in a slump. Pay cuts will be rare.

While it's true that the Standard & Poor's Case-Shiller home price index is down 20 percent from its peak in July 2006, it's still higher than it was in May 2004. In other words, the value of many homes, probably most, is as high as it was 3 1/2 years ago.

Keep in mind that deflation is a broad, sustained decline in prices, not just an occasional monthly dip. Should we really expect the cost of medical care, tuition, textbooks, movie tickets and other services to decline steadily?

It's not impossible, of course, though I think the bottom truly would have to fall out of the economy for even mild deflation to occur.

CPI Debate

Only a few months ago, many economists -- and several Federal Reserve policy makers -- were debating whether the 12- month change in the overall CPI, which hit 5.6 percent in July, would move down toward the core index, or the core would accelerate.

With the October decline, the overall index was still up 3.7 percent from October 2007. The 12-month increase in the core, after peaking at 2.5 percent in July, was 2.2 percent last month.

On Nov. 19, Fed Vice Chairman Donald L. Kohn said during a conference at the Cato Institute in Washington that he agrees the economy is ``very weak.'' Asked about the prospect of deflation, Kohn replied, ``There is a risk out there, but in my mind it is still small.'' He said the risk was substantial enough to warrant being ``aggressive in our monetary policy.''

Jeffrey Lacker, president of the Richmond Federal Reserve Bank, said in an interview the following day, ``The risk is still quite minor.''

First Rate Increase

Lacker said he expects the economy to begin picking up sometime next year. When it does, he is intent on moving promptly on monetary policy to make sure inflation doesn't worsen again.

``I worry about us keeping rates too low, too long,'' Lacker said. ``There is always a hesitation about making that first rate increase.''

If the economy does begin to expand again next year -- as many economists expect to happen -- it will be in part because the Fed has been aggressive in using monetary policy. The central bank failed to do that at the beginning of the Depression. So did the Bank of Japan during much more modest deflation in the 1990s.

Fed officials are conscious of the example of Japan. That was the key reason the Federal Open Market Committee lowered its target for the overnight lending rate to 1 percent in 2003, when inflation threatened to disappear entirely.

In response to the current financial crisis, the Fed has lowered the target once more to 1 percent, down from 5.25 percent in September 2007. The FOMC may reduce it again, perhaps by 50 basis points, when it meets Dec. 15-16.

It has also flooded the banking system with cash and extended loans in unprecedented fashion.

Obama and congressional Democrats say they will provide fiscal stimulus as soon as he takes office. Too bad that, in the meantime, President George W. Bush is just sitting on his hands.

(John M. Berry is a Bloomberg News columnist. The opinions expressed are his own.)

To contact the writer of this column: John M. Berry in Washington at jberry5@bloomberg.net

Last Updated: November 24, 2008 00:01 EST