Despite Falling Prices, Economy Is Growing
July 28, 1997
So far in 1997, producer prices have fallen at an annual rate of 3.4 percent. In fact, they have fallen continuously for six straight months (see figure). At the same time, commodity prices have fallen sharply in recent weeks and the price of gold has plunged. The CRB (Commodity Research Bureau) index of commodity prices is down 6 percent since May, while the price of gold has fallen 15 percent in the last year.
All of these signs have led some economists to suggest that we may have entered an era of deflation. Historically, economists have viewed deflation as a greater problem than inflation. Deflation increases the burden of debt and labor costs while reducing business profits. Together, these effects raise the risk of a financial collapse that can degenerate into a depression.
So far, no economist is predicting a repeat of 1929. Partly this is because many view the factors that have caused producer prices to fall to be temporary. Federal Reserve Chairman Alan Greenspan clearly falls within this camp. In congressional testimony last week, he pointed to a rising dollar, which lowers the cost of imported goods, and changes in the health care industry as two major elements of falling prices which cannot continue indefinitely. He further suggested that the restraint workers have shown in terms of higher wages may not last much longer.
On the other hand, Greenspan noted that deregulation and higher capital investment have also been important in restraining prices. These factors may continue to exert downward pressure for some time to come, because they raise productivity. Higher productivity allows businesses to increase both wages and profits without raising prices.
Historian Alvin Rabushka notes that rising productivity and declining prices were the hallmarks of Britain's greatest period of growth in the late 19th century. Falling prices meant that real wages were rising, which led to increased consumption and higher standards of living for workers, especially for those at the bottom of the income scale. As is the case today, the sources of this prosperity were capital investment, technological innovation and free trade.
It may be too soon to proclaim the birth of a new Golden Age, but the signs are very positive. Chairman Greenspan points particularly to the fact that continued growth has forced employers increasingly to reach out to the hard-core unemployed for labor. The experience and on-the-job training these workers are receiving may help keep them employed for many years to come. And the latest data from the Federal Reserve show the net worth of households doubling in the last 7 years, from $6.9 trillion to $13.5 trillion.
Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, July 28, 1997.
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