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What Happens When Prices Fall

By Chris Farrell

HarperBusiness -- 228 pp -- $22.95

Readers coming across the new book by BusinessWeek contributing editor Chris Farrell, Deflation: What Happens When Prices Fall, may be forgiven if they have the same reaction as an executive he quotes. "You think there's going to be deflation?" he said to Farrell. "Well, I think you're nuts."

But that might be shortsighted. Yes, the economy is booming now, and inflation fears are rising as prices of everything from gas to milk head up. But it was only last year that Federal Reserve policymakers and financial market investors were fretting about the dangers of a deflationary downturn in the economy, with prices and demand dropping in tandem.

Farrell argues that the Fed and the markets were right to suggest that deflation was a possibility. In fact, he avers, last year's brush with deflation won't be the final one.

The author identifies several reasons for thinking that "over the long haul, deflation is here to stay." Price competition among businesses will remain fierce in the future, he believes, thanks to deregulation at home, the spread of capitalism abroad -- including to China and India -- and the growth of information technology, which boosts productivity and cuts costs. That doesn't mean there won't be the occasional inflation scare, of course. But should inflation show any signs of a pickup, the Fed, backed by the markets, can be counted on to swat it down, he says.

This supply-side-driven deflation is a lot different from the price collapse of the Great Depression, when the economy caved in. In fact, Farrell says, it's more akin to the U.S. experience of the late 19th and early 20th centuries. Back then, falling prices and rising living standards went hand in hand, as the economy transformed itself from an agricultural republic into an industrial powerhouse. So supply-side-driven deflation is something to be welcomed, not feared.

In clear prose, Farrell lays out what this new deflation-prone era means for workers, companies, investors, and policymakers, recommending what each can do to cope. If he's correct about what lies ahead, it's advice worth listening to, in spite of today's inflation jitters.

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