Too much of a good thing?

Maintaining stable prices is one of the three pillars of US monetary policy. Although commonly associated with inflation, price stability also seeks to manage lowflation, or worse deflation, which is just as disruptive to a growing economy. Measuring the Impact of Falling Prices The US economy had two periods of sustained price declines in the past 100 years. From late 1929 to early 1933, prices fell at an annualized rate of 8.7 percent. From the middle to the end of 2008, prices fell at an annualized rate of 10.3 percent. 1 These price declines marked two severe economic contractions, the Great Depression of the 1930s and the Great Recession of 2008-2009.

The average consumer who learned about The Great Depression in high school, or more recently, watched news accounts of Japan’s economic meltdown beginning in the mid-1990s, understands why deflation can send an economy into a downward spiral. But what is so bad about lowflation, especially as the effect has been low interest rates, and a price decline in some everyday goods and services, such as gasoline?

According to Morgan Stanley economists, lowflation marks the point at which prices are rising at well below the Federal Reserve’s target inflation rate for months, even years, persistently teetering on the edge of deflation. At this level, lowflation can exert its own steady, downward pull, all the more insidious because it can be so low-key and off-the-radar.

Economists have mapped out three major side effects from lowflation: the higher cost of repaying loans for those who hold a lot of debt; the inability to cut real interest rates when nominal rates are near, or at, zero; and the damage to central banks’ credibility as they fail to meet inflation targets and start to run out of policy options.

Focusing on the Future Economic growth may return to historical levels as the US economy continues to recover its footing in the aftermath of the Great Recession. In the meantime, we can expect additional central bank intervention, domestic and foreign.

Have you re-evaluated your saving and investing program to take into account the current economic policies and the risks posed by low prices?