The Washington Post warned us of the evils of deflation in a front page story. The Post, whose main expert on house prices during the boom years was David Lereah, the chief economist for the National Association of Realtors, told readers that: "'Everyone is having these huge sales, and consumers know if they wait longer, the chances of them not having a good selection is fairly small and the chances are that the prices will be lower,' said Charles McMillion, an economist who runs MBG Information Services. 'So why buy today? This is exactly why economists are always scared to death of deflation.'" Okay, so let's parse this one. If prices are falling, why should we buy items today when we can get them for a lower price next month? That's a real good question. Has anyone bought a computer in the last two decades? I have run across a few people who have. According to the Commerce Department, computer prices have been falling at the rate of more than 30 percent a year over most of the last two decades. If people felt that it made more sense to wait for prices to drop, we should expect the computer market to have been very weak. That isn't quite consistent with the explosion in computer sales over this period. But, returning to the other items that might fall in price, if we turn to Japan, which supposedly suffered from deflation for a decade following the collapse of its bubbles, the rate of deflation was typically less than 1 percent a year. (Prices did rise in some years during this decade.) This means that for a typical item in a typical year, the price would be falling at a rate of less than 0.1 percent a month. That means the pair of pants that i could buy today for $30 will cost just $29.97 cents next month. If I put off buying for two months, then I would only have to pay $29.94. You could easily understand how this would discourage consumption. Of course, the actual rate of deflation was slower in most years. Now, there is a real sense in which falling prices do pose a problem, but that it primarily with houses, which do not even appear in the inflation indexes. Falling house prices reduce the wealth of homeowners and can put those with a mortgage underwater. This is a huge problem, but it is not the deflation story highlighted by the Post. It is true that economies that are experiencing economic weakness are more likely to see deflation than other economies. But this confuses cause and effect. The deflation is a symptom, not a cause. There is one final point worth noting about this issue. The "deflation" highlighted in this article is primarily the result of a plunge in commodity prices. This plunge reversed a sharp uptick in the price of oil and other commodities over the last two years. It is not clear that commodity prices will continue to fall. In fact, it is entirely possible that prices will quickly reverse course and rise sharply from current lows. This would quickly eliminate the Post's concerns about deflation.
--Dean Baker
