'Main Street' Deflation Influences Obama's Cabinet Picks

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KORVA COLEMAN, host:

I'm Korva Coleman, and this Tell Me More from NPR News. Michel Martin is away. Coming up, it's widely known that future first lady Michelle Obama plans on having her mother move to Washington next year to be with the family. So today, we have a special grandmom segment to talk about the role they play in raising a family. But first, a look at the economy.

President-elect Barack Obama is focusing attention on the economy, naming key advisers, including Timothy Geithner as Treasury Secretary. The Obama transition team is also in the process of compiling a stimulus plan that could cost as much as $700 billion over the next two years. The new administration wants to act quickly after the January inauguration, hoping to undo the widening damage of a web of economic woes, home foreclosures, failing financial institutions, massive layoffs, and now a new threat, deflation.

At first glance, deflation seems like it's a good thing. Things cost less because businesses cut prices in order to lure shoppers. Lower prices are great, right? Be careful what you wish for. To talk about the specter of deflation, we're joined by our regular financial contributor, Alvin Hall, and by NPR's David Kestenbaum, who's been covering the economy. Welcome to both of you.

DAVID KESTENBAUM: Thank you.

ALVIN HALL: Glad to be here.

COLEMAN: David, what exactly is deflation? Why does it happen?

KESTENBAUM: It's exactly what you laid out. It's a steady, continuing decline in prices. So you go out to get your hair cut this week, it costs one thing. You go out next month, and it's a little less and a little less and a little less, and the same with the gallon of milk and if you're buying steel to make cars. If you look at the price out next year, it's a little less. And we're actually seeing some of that now. And it happens - it can happen for a lot of reason, but one reason is just people are spending less. And so you see people dropping the prices so that they can still continue to sell things.

COLEMAN: Alvin Hall, why is that bad?

HALL: That's bad because eventually, all those businesses' profits will go down. Then they'll have to lay off workers. More workers will go on the unemployment lines. Less money will be spent, and it'll start a slow but sort of snowball effect of the economy getting worse and worse and worse.

COLEMAN: This is frightening. How do we stop it?

KESTENBAUM: It's called - that's called the deflationary spiral.

COLEMAN: Oh, no.

KESTENBAUM: Well, the way to do it is you cause inflation. You put more money out there. And, you know, one way to do it is the fed can lower interest rates, so it's easier for banks to borrow money, so there's more money out there.

HALL: And this isn't new. This happened in Japan. And they took interest rates all the way down to zero, and it still did not necessarily stop deflation. It's a real tricky thing to stop. And David is right. You can lower the interest rates and try to get money flowing quickly through the economy. But if you have a huge number of people who've been laid off, and no one is spending, and businesses are just sitting there stagnant, it's hard to stop deflation.

COLEMAN: What's the current rate now?

KESTENBAUM: Well, actually, you can look at the consumer price index, which dropped one percent in October. There's another thing called the producer price index, which - it's sort of like inflation for businesses or deflation. That number also dropped way down, so we're seeing a bit of it. I think the sense from economists is that it's not happening yet, and that's why it's time to act now.

COLEMAN: Alvin, do economists agree?

HALL: Pretty much, but I would love to take the economists around stores in New York City, Washington, D.C., Chicago, or San Francisco and look at the price markdowns in all of these stores. And the stores are still empty. There was in Saks Fifth Avenue this past weekend, they marked handbags down 40 percent and then another 50 percent on top that. Well, that got people out, so you had handbag wars temporarily. But this morning when I went through, it was still pretty much empty.

KESTENBAUM: I should go shopping with you. I was at Linens-N-Things, which was having a bankruptcy sale, and all there were were some sort of off-color towels left.

HALL: Yes. But I think it's - I think this deflation thing is serious, and economists recognize that they must stop it now.

KESTENBAUM: It's really scary for them because inflation, you know how to stop. You know, you just raise interest rates. But deflation, you can't go below zero. Once you lower your interest rates to zero, you have to do something else. And Ben Bernanke has said, look, there are other, the Fed chairman, has said there are other things you can do. He was once called Helicopter Ben because he suggested in, I don't remember, testimony or something, that you would just have - you had deflation, you would have helicopters come drop money everywhere, and that may be sort of what we're doing with an economic stimulus package.

COLEMAN: Well, the Federal Reserve's discount rate is at one percent, and you were saying you can't go below zero. So if the Fed has very little wiggle room, what do we do? Fasten our seat belts, have a bumpy ride?

HALL: Put more money into the economy and speed up the velocity of money through the economy. Right now, we're noticing that the money is slowing. When banks get money today, they hold onto it, because they're afraid to lend it out to somebody else for that entity or that individual may go bankrupt.

They are afraid to loan it out to people to buy homes, because the homes are dropping in value. So, the money is sort of clogged up. What they need to do is find some way to stimulate the flow of money through the economy. And in essence, dropping huge amounts of money in the economy would, they hope, do that.

COLEMAN: Do we take a stick to them? Do we prick them with a pin?

HALL: Oh, I think we wave our hands and pray.

(Soundbite of laughter)

COLEMAN: Well, how about this, what about this proposed stimulus package that President-elect Obama is talking about? David, would that do any good?

KESTENBAUM: It would certainly do some good. I mean, that is another way you can get money out there - spread by the government, spending it like that. So I think that and the fact, it doesn't seem related, but the fact that the government is trying to make sure banks don't fail, that was one of the reasons deflation got out of hand after the Great Depression is that, you know, if banks can't lend money to people, then the economy really slows, and then that sort of feeds the whole deflationary cycle. So, it doesn't seem directly related, but in trying to make sure the banks keep functioning, they are helping to try and make sure deflation doesn't happen in earnest.

COLEMAN: If you're just joining us, you're listening to Tell Me More from NPR News. We're talking to our regular financial expert, Alvin Hall, and to NPR's David Kestenbaum about deflation, what it is and how it might affect your money.

Alvin Hall, if you had to rank woes, what would come first, deflation, inflation, joblessness, credit markets freezing? Are they all bad, or is there one that's worse than the other?

HALL: They're all bad, but I would have to put the credit markets freezing and joblessness as the two most important ones. When people are jobless, or there's the threat that they will lose their job, they will stop spending. And that slows down money to the economy immediately. Think about yourself. If you knew that within three months your job would be on the line, would you be going out and spending as much on Thanksgiving and Christmas during this season? You wouldn't do it. So that slows money down.

And then, businesses and other entities need money in order to fund acquisitions during these bad times to smooth over the good times and the bad times. And banks being unwilling to loan that money also further contribute to that because then they don't have money to hire people. They can't absorb the downs in the market right now, so that adds another domino effect.

COLEMAN: David, is there any chance that this possible slide toward deflation will be halted or slowed before President-elect Barack Obama takes the oath of office?

KESTENBAUM: Oh, if I knew that, I would probably be able to make a lot of money on that information.

(Soundbite of laughter)

KESTENBAUM: I don't, you know, it's clear that consumer confidence here, that just people feeling like things will be OK is an important part of fixing this. And that's why I think you saw Obama out yesterday talking about, you know, here's where we're heading with our economic team. We have things well in hand, and we have people who know what's going on who are going to help make it better. You know, that's why he's not waiting to do that. That's why he's doing that now.

COLEMAN: Alvin, the day after Thanksgiving is generally known as Black Friday.

HALL: Yes.

COLEMAN: We all line up real early. Those of us who choose to go shopping, or can afford to go shopping, trying to clean up on the huge sales. Will holiday sales help ward off the threat of deflation?

HALL: I think that people are going to pull back and wait for things to get even worse and for retailers to mark things down even further. I think there's a core group of people who go out to get toys on that day. But if you've been reading the newspapers or looking at the ads anywhere, you can see that the markdowns have already started. They're only going to get deeper.

I'd like to say something relative to what David said about the psychological element of this. I completely agree with him on that point. But I also think that when people are scared, when job security is undermined, when you've been sitting in an office and, you know, your colleagues on either side of you have been laid off, you are more inclined, whether for psychological needs or real financial needs, not to spend money. And I think it will take more on Barack Obama's part than making us feel good about the overall economy to encourage people to actually go out and open their purses and pocketbooks.

KESTENBAUM: I think that's right. I mean, it's easy to point to people and say, why aren't you spending more money? But you know, people are doing what we've been encouraged them to do which is to be careful about their finances, you know?

HALL: Yes.

KESTENBAUM: They're uncertain the way everybody is uncertain.

HALL: Yes.

KESTENBAUM: You look at the stock market, people are pessimistic, but it's also going up and down and up and down. What that really shows is people don't know...

HALL: Yes.

KESTENBAUM: What is going to happen. It shows there's enormous uncertainty and, you know, people in a small way, they're not a company, but they feel that same uncertainty and so, you know, they're - some of them are being very prudent.

COLEMAN: So, David, with this uncertainty, what does Obama have to do?

KESTENBAUM: That's why it's his job.

(Soundbite of laughter)

COLEMAN: Alvin?

KESTENBAUM: Alvin, you got an answer? You want to - there's still some positions open in his Cabinet, though, if you want to make a pitch.

HALL: Yeah. Well, I really do think that having a stimulus package that will put money into the hands of individuals and create jobs - I think the sense that the jobs are disappearing is pretty frightening to people.

Let me just speak about my own situation working and training on Wall Street, which I've done for 25 years. This is the first year in 15 or 20 years that no clients have booked work for 2009. If I go to every firm I've worked for, only at one firm in all the Wall Street firms is the same person. There are groups of people, they have all been laid off. I talk to them all the time and they are terrified. Some of them, they range in age from 30s to 61 or 62. And they're all saying, what am I going to do? So they're holding onto their money. So I think by giving people a sense that there will be jobs created by either helping these corporations or encouraging them to spend part of the money they were spending on executive salaries with the average rank and file people that will help people feel a little more secure.

COLEMAN: You think that will have an effect now, or do we have to wait until January 20th to feel that confident?

HALL: I think we have to wait until January 20th. I don't think there's anything that can be done now during this lame-duck administration that is going to make people feel better immediately. I know I would not go out and spend over the holiday season right now, recklessly, thinking that, ooh, it's going to get better in January, and only to discover in January that it doesn't get better.

COLEMAN: Alvin Hall is a regular contributor and financial expert who joined us from our New York studios. David Kestenbaum covers the economy for NPR as part of our Planet Money team, which is answering your questions at npr.org/money. He joined us here in our Washington studio. David, Alvin, thanks very much.

KESTENBAUM: You're welcome.

HALL: You are welcome.

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