Specter of Deflation Rises Again - WSJ

Supply-chain snarls are boosting certain prices, but the big risk for the U.S. economy is deflation

In 2002, former Federal Reserve Chairman Ben Bernankegave a speech titled “Deflation: Making Sure ’It’ Doesn’t Happen Here.” Now, the severity of the recession brought on by the novel coronavirus crisis could make that task very hard.

The Labor Department on Tuesday reported that overall consumer prices fell 0.8% in April from March—the largest monthly decline since December 2008—putting the index up just 0.3% from a year earlier. Core prices, which exclude food and energy prices to better capture inflation’s trend, fell 0.4%,...

In 2002, former Federal Reserve Chairman Ben Bernankegave a speech titled “Deflation: Making Sure ’It’ Doesn’t Happen Here.” Now, the severity of the recession brought on by the novel coronavirus crisis could make that task very hard.

The Labor Department on Tuesday reported that overall consumer prices fell 0.8% in April from March—the largest monthly decline since December 2008—putting the index up just 0.3% from a year earlier. Core prices, which exclude food and energy prices to better capture inflation’s trend, fell 0.4%, marking their largest drop in the history of the data, and were up just 1.4% from a year earlier.

The exact readings on consumer prices in April are, to an extent, less meaningful than usual since the consumer spending baskets the Labor Department bases its price indexes on don’t reflect people’s spending behavior during the coronavirus epidemic. Gasoline gets a 3% weighting in the overall index, for example, but people aren’t driving nearly as much. Food away from home gets 6.2%, but people aren’t spending much time at restaurants.

Indeed, as they hunkered down at home, many people’s spending experiences were more inflationary than what Tuesday’s report entailed. Prices for groceries and other food-at-home items rose 2.6% in April from March, for example.

But the ultimate effect of the crisis seems more likely to weigh on prices than to inflate them, and might ultimately lead to a general decline in prices, or deflation. Although the supply of some goods like fresh meat has been constrained by supply-chain snarls and other issues, surging unemployment will severely constrain many people’s ability to spend, sapping overall demand.

For the Fed, the possibility of deflation is a major worry. That is because when prices fall, it is even harder for borrowers to pay down existing debts, leading to rising defaults, while banks become more leery about extending credit. The economy struggles to grow as a result, making recovery even harder to achieve. These fears are partly why the central bank’s policy was so easy before the coronavirus crisis hit. With its preferred measure of core inflation running persistently below its 2% target for overall inflation, the Fed was worried that in the event of a downturn it could face a deflation problem.

But this is unlike any downturn the Fed has had to deal with since the Great Depression—the last time America experienced deflation. In the aftermath of the 2008 financial crisis, core inflation fell as low as 0.9%, but inflation had a higher starting point heading into that recession, and the unemployment rate topped out at 10%—below the 14.7% it reached last month. Unless the labor market snaps back very rapidly, which appears unlikely at this point, consumer prices will continue to face pressure.

In that 2002 speech, Mr. Bernanke, then a Fed governor, laid out a plethora of measures that the central bank could use to combat deflation—many of which, including buying longer-maturity Treasury debt, the Fed has already embarked on. In the extreme, there was his mention of Milton Friedman’s “helicopter drop” experiment—what would happen if a helicopter flew over a community and dropped cash? If deflation takes hold, the Fed coming up with a way to finance payments to households could become a real possibility.

Write to Justin Lahart at justin.lahart@wsj.com

https://www.wsj.com/amp/articles/specter-of-deflation-rises-again-11589300191