Opinion Editorial | |
| Monday, January 12, 1998 | |
Interest Rate Fall May Signal Mild Deflation |
On January 3, Federal Reserve Board Chairman Alan Greenspan gave an important
speech in which he discussed the question of deflation. Since many people
in financial markets have come to believe that deflation -- falling prices
-- is now a greater risk than inflation, Greenspan's speech may give us
important clues to monetary policy in the coming months. To consumers who still see prices for food and clothing rising steadily,
any discussion of deflation must seem ridiculous. However, the prices that
consumers pay are the ultimate result of a long chain of commodity and producer
prices. Changes in these prices, therefore, may indicate where consumer
prices will go in the future. Since many such forward-looking indicators
of consumer prices are trending downward, there is a good possibility that
consumer prices too may fall in the future. Prices for financial assets may also indicate the future direction of
consumer prices. Among the most closely watched is the yield curve for
Treasury securities.
The yield curve has lately become very flat, with long-term interest
rates only slightly above short-term rates (see figure). This flattening
of the yield curve has come about entirely because long-rates have fallen
sharply as inflationary expectations have diminished. There is some debate among economists as to what effect deflation would
have on interest rates. Indications are that mild deflations are bullish,
leading to lower long-term rates, but more severe deflations cause rates
to rise. According to economist Steven Leuthold, long-term rates averaged
4.6 percent when prices fell one percent. But when prices fell six percent
or more, rates rose to 5.7 percent. For this reason, Mr. Greenspan does differentiate between a mild deflation,
which can be absorbed by the economy without serious disruption, and a persistent
deflation that could lead to serious economic dislocation. Nevertheless,
it is clear that he believes price stability, neither inflation nor deflation,
should be the goal of monetary policy. Traders in financial markets took Greenspan's comments favorably, causing
the yield on Treasury's 30-year bond to fall to an all-time low. They also
feel confident that if true deflation does emerge, the Fed will keep it
in check. Source: Bruce Bartlett (senior fellow, National Center for Policy Analysis),
January 12, 1998. Home | Support Us | All Issues | Social Security Debate Central | Contact Us |
