Fed Watches For Signs Of Deflation

When Federal Reserve officials meet, the discussion usually focuses on inflation and how to restrain it. But at Tuesday's meeting, the conversation is likely to touch on growing fears of deflation — a decline in wages and prices. David Wessel, economics editor of The Wall Street Journal, talks to Steve Inskeep about whether the condition of the economy.

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STEVE INSKEEP, host:

Now, when Federal Reserve officials meet, the discussion usually focuses on inflation and how to restrain it. But at today's meeting of Fed officials, the conversation is likely to touch on growing fears of deflation. That's when wages and prices fall.

David Wessel will be following today's meeting. He's the economics editor of the Wall Street Journal and a frequent guest here.

David, good morning.

Mr. DAVID WESSEL (Economics Editor, The Wall Street Journal): Good morning, Steve.

INSKEEP: So are we actually experiencing deflation?

Mr. WESSEL: No, but we're a little too close for comfort, at least for some people at the Federal Reserve. Inflation is very low, but prices are not yet falling. It's true that the Consumer Price Index has fallen three months in a row, but that's mostly on the ups and - more recently - downs of oil prices. If you take out oil, which tends to bounce around a lot, the prices are climbing at a very slow, 1.2 percent pace - much slower than the Fed's target for inflation. And it's - the inflation seems to be creeping down, and when you're so close to zero, that's created a lot of fears that it won't take much to push it under and to - the economy, a weak economy to deteriorate into deflation.

INSKEEP: What problems would that create?

Mr. WESSEL: Well, it seems kind of attractive, falling prices. After all, if inflation is bad, then you'd think deflation would be good. But there are a couple of issues. One is: It's not just prices that fall. Wages fall, too. Second: It makes it harder to pay back your debts because your income may go down, but the size of your mortgage or your car loan will not. And...

INSKEEP: Oh, because the dollar is actually worth more. And so, it takes you -it's harder for you to get the dollars to pay back your debts, and people have so many debts right now.

Mr. WESSEL: Exactly. And it also makes it hard for the Fed to stimulate the economy because usually, what the Fed's trick is, it pushes the interest rate below the inflation rate. That means the inflation-adjusted interest rate is negative. But you can't do that once you get to zero, and that's where they are now.

INSKEEP: So how worried is the Fed, really, about the risk of deflation and what - if anything - can they do about it?

Mr. WESSEL: Well, they are seriously worried about deflation because we have such little inflation at a time when the government has injected so much money, when the Fed has put $1.5 trillion of money into the economy, have printed that much money electronically, and still we have only a little bit of inflation. So that makes them worried that it wouldn't take much, if the economy weakens or something else goes wrong, for the prices to fall.

INSKEEP: Okay. So we know what the federal government can do about inflation and the Federal Reserve can do about inflation, but what can they do about deflation, if anything?

Mr. WESSEL: Well, what the Federal Reserve, the central bank can do, basically, is print money, lots of it. Milton Friedman, the great economist and Nobel Prize winner, once said that all they'd have to do is hire a helicopter and throw dollar bills out of it, and if they threw enough out, prices would go up.

(Soundbite of laughter)

Mr. WESSEL: And so basically, the conversation that the Fed is having right now is, what should we do if the inflation rate continues to fall? Should we effectively begin printing money again - as they did earlier in the crisis, by buying bonds, buying mortgages and stuff like that? They're not there yet. But it's a contingency planning that's going on at the Fed, which is a real surprise to them, because they didn't expect to be having this discussion at this meeting today.

INSKEEP: Are there lessons to be learned from other countries, here?

Mr. WESSEL: Well, the famous example, of course, is Japan has been suffering from deflation for a decade. I think the biggest lesson is, it's a whole lot harder to solve this problem than we thought - when American economists and government officials were telling the Japanese to do this, that or the other thing to get out of this hole. Now, they're a little bit more humble.

INSKEEP: David, thanks very much.

Mr. WESSEL: You're welcome.

INSKEEP: David Wessel is economics editor of the Wall Street Journal.

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