Originally found at news press
DEFLATION: The opposite of inflation, a gradual drop in the cost of goods and services usually caused by a surplus of goods and a shortage of cash, which leads to unemployment, recessions and depressions.
So, before you applaud the fact that the cost of a new car has fallen or a flat-screen TV is cheaper than a year ago, you might want to consider the long-term effect it can have on the economy.
“Deflation is not our friend,” said David Jones, a retired Wall Street executive and now an economics professor at FGCU.
Here’s why:
A drop in demand for goods and services gradually leads sellers to drop prices on inventories to get rid of overstocked material.
Then, the dominoes begin to fall, especially when there are negative trends in the Producer Price Index and the Consumer Price Index, both of which fell nation-wide last month. The PPI and CPI are monthly indices that measure levels of inflation.
Lower demand leads to a slowdown in business, which in turn triggers a cut in investment. Next comes a sluggish economy, business and industrial capacity shrinks, and before you know it, the economy sinks into a quicksand of negative growth.
From Jones to Nobel laureate Paul Krugman to a group of 53 Wall Street economists, the word is deflation is a threat to the economy in the foreseeable future.
Why? The short answer goes like this: You can raise short-term interest rates to check rising inflation. But when interest rates are at zero, as they are now, they can’t be cut any more. So lesser tried-and-true techniques, such as printing more money, must be used.
And, as Jones explained, when there is a fear of deflation consumers put a padlock on their wallets.
“When prices start to go down, like in real estate, people wait for them to go down further,” he said. “They will wait to buy an automobile, figuring the price will drop. It becomes self-reinforcing.
“It shatters business confidence. Then you get layoffs. It becomes a vicious circle.”
Peter Lopez, the manager of Good Deals Appliances in Fort Myers, said customers are spending-cautious now.
“Yes, they are holding off on buying,” he said. “The main thing we are getting now is ‘Do you have used?’. People are looking for used merchandise; they can’t afford new.”
Southwest Florida homeowners know firsthand the devastating effects of deflation.
“For consumers, falling prices may be looking beneficial,” said Howard Finch, the Alico Chair in Financial Management and Planning at FGCU. “But that’s likely to include the value of your house. As well, any other of your hard assets are likely to be declining, too.”
Finch said deflation affects not only the balance sheets of Wall Street but the psyche of Main Street.
“It has a paralyzing effect on spending money,” he said.
For now, anyway, the declining value of real estate has been the biggest deflationary issue here. Since the big runup in the middle of the decade, the median price of a home sold by a Realtor in Lee County has fallen by more than 60 percent, from a high of $322,300 in 2005 to the current $96,600.
But the Consumer Price Index for the Miami-Fort Lauderdale area — the closest reporting location to Lee County — shows a decline of prices in recreation, apparel and housing over the past year. Overall, prices were almost flat the past 12 months, rising just 0.4 percent.
Gary Jackson, head of the Southwest Florida Regional Economic Institute, said the southeast Florida numbers appear to be in line with this area.
“Deflation is always a big issue,” Jackson said. “People are worried about losing their wealth and their jobs and being upside down on their homes.”
Jones, who ran a Wall Street bond firm that was purchased by a Japanese company, knows firsthand the kind of malaise deflation can cause.
“Look at Japan,” he said. “They’ve had two decades of no growth.
“Most of the time deflation is a bad thing. Wages go down as prices go down, but your debt burden stays the same. That’s part of the reason for the wave of bankruptcies.”
Finch echoes Jones.“Deflation is very scary because of the damage it does to the balance sheets,” he said. “This is a big part of what has happened to our banking system. … It was a big story associated with the (Great) Depression.”
The opposite of deflation is inflation, when prices and wages rise. In an ideal economy, a 1 percent to 3 percent yearly rise is optimal, but some experts are not afraid of it going higher.
Nobel winner Krugman is one of them. Writing in a recent paper, he said inflation, while barely over zero, is below the Federal Reserve’s target of about 2 percent — and that’s bad news.
“And no,” he wrote, “4 percent inflation wouldn’t turn us into Zimbabwe. I remember when we had stable inflation of around 4 percent — and it was morning in America.”
Here’s why:
A drop in demand for goods and services gradually leads sellers to drop prices on inventories to get rid of overstocked material
