Zero Inflation. Savor The Moment
Sweet victory. Price stability in our time. It may not be as portentous as the end of the cold war or as flashy as balancing the budget, but the virtual end of inflation, as signaled by Federal Reserve Chairman Alan Greenspan recently, is cause for celebration. It marks the final chapter in the 20-year battle against inflation that began when Paul Volcker became head of the Federal Reserve. Before we begin fretting about the flip side of inflation--deflation--let us savor the moment.
Most consumers have been wondering where inflation has gone. For every hike in cable bills, movie or airline tickets, they see declines in prices for computers, clothes, gasoline, even autos. College costs and medical inflation are down below 3% annually from their double-digit highs. Average it all out and the consumer price index is running at about a 1.8% rate. Pretty low. Add in the fact that Greenspan and many other economists believe the official statistics will still overstate inflation by about 1% even after the upcoming recalibration of the CPI. Take a look at Europe and much of Asia, and everyone around the world is approaching price stability.
It's nice not to have to worry about ever rising prices. Business decisions can be made on fundamentals, not on price expectations. That's pretty much true of households as well. Companies that want rising profit margins have to innovate or cut costs. The resulting productivity can pay for real wage gains. A nice, virtuous cycle.
The worry, of course, is that zero inflation will slide into deflation. When people believe that prices will fall continuously, they hold onto their money rather than spend it. Prices drop faster than unit sales grow, so corporate profits plummet. Growth suffers, recession results. Japan has been in a deflationary spiral for several years now. Asset prices for land, housing, and equities are half of what they were in the 1980s.
If fret you must, keep your eye on U.S. corporate earnings. The meltdown in Asia is far more severe than anyone at the Fed or in the Administration ever anticipated, and it could get worse. If earnings begin to fall sharply and the market tanks, then deflation could get ugly. Asset deflation a la Japan will set the alarm bells off at the Fed.
Fortunately, the end of inflation gives the Fed more leeway to deal with economic downdrafts than it has had in decades. So if it comes down to it, Greenspan has plenty of room to cut interest rates.