While most Americans just want to know how much a carton of eggs is going to cost, economists have a whole vocabulary for how to predict that statistic.
When the Fed meets to discuss how much inflation has come down, it doesn’t mean prices are falling. It just means that already-high prices are rising more slowly than they did previously, giving shoppers a bit of a break. But it does raise the question: Can prices actually fall? And would that be a good thing? Here’s a quick rundown:
What is deflation?
Deflation is the term economists use for a sustained period of dropping prices. Intuitively, it’s the opposite of inflation. Essentially, it’s a pattern of goods getting less expensive as consumer demand falls.
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Like inflation, deflation can be cyclical. If consumers see that prices are falling, they may be more likely to put off purchases to see if goods and services become even cheaper. Lower consumer spending pushes companies to cut wages, and then people buy even less and prices continue to drop.
Repaying debt on credit cards and mortgages also can become more of a challenge during a period of deflation as technically the money being paid back is now worth more than when they borrowed it.
Is deflation worse than inflation?
Everything in moderation. Both economic states can be positive or negative depending on the extreme to which they reach.
Continuous inflation or deflation left unchecked can wound the economy. While deflation can drive down prices, which is good, profits and wages may also suffer and repaying debt becomes expensive. And if consumers put off purchases because prices are low, it can cause a vicious cycle that keeps the economy in a rut.
Inflation, on the other hand, can make the economy too hot: Wages grow but so do prices, leaving consumers facing sticker shock and eroding their purchasing power.
To measure deflation, economists most often set aside energy and food prices, which tend to be more volatile. The Federal Reserve instead uses a barometer known as the Core Personal Consumption Expenditures (PCE) price index.
The latest numbers for the PCE, which the Fed monitors closely, showed prices rose 0.4% from March to April, meaning inflation remains hot (but not as hot as before.) Despite the rising prices, the accompanying numbers for consumer behavior showed American shoppers are eager as ever and the economy may be more resilient than some who predicted recession had projected. Spending jumped 0.8% from March to April, the biggest increase since January.
No deflation is in sight just yet.
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