NCPA - National Center for Policy Analysis

Is Deflation A Possibility?

July 19, 1997

Some economists are finding signs of deflation in the economy -- a rare phenomenon in post-war times. Deflation happens when the general price level declines and the dollar's purchasing power rises.

Most official price gauges still show some signs of inflation, especially in services. But they show overall prices rising at an even slower rate -- known as disinflation. And some key inflation indicators -- producers' prices, gold, even commodities -- are falling.

  • The Labor Department reported a 0.1 percent decline in the June producer price index -- representing the sixth straight month of decline.
  • Since the start of 1996, gold has fallen steadily -- dropping about 20 percent to $320 an ounce.
  • Some economists say that competition has increased rates of production, with the quantity of goods being produced outstripping increases in demand.
  • The number of S&P 500 companies with negative sales growth has doubled over the past two years.

Demand is possibly being held in check, some economists argue, because -- as governments around the world have down-sized and cut back on spending -- more resources have gone to the private sector. Since that sector is more efficient, inflation is cut even further.

Researchers at Donaldson, Lufkin & Jenrette point out that the number of people turning 25 and forming families will drop nearly 8 percent in the U.S. this year -- a steep decline. Obviously, that will result in reduced demand.

Proof that deflation is actually taking place would be cause for the Federal Reserve to lower interest rates. Many economists are predicting it will do just that later this year.

In a deflationary environment, consumers would benefit from falling prices, but companies would have to rein-in costs and innovate -- rather than raise prices -- to make profits. And investors would have a harder time finding profitable companies.

Source: Anna J. Bray, "Is Deflation the Real Threat?" Investor's Business Daily, July 17, 1997.


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