WASHINGTON — Many Americans are in a down mood about the economy for one main reason: Prices feel too high.
They may not be rising as quickly as before, but average prices are still painfully above where they were three years ago. And they usually go even higher.
Take a 2-liter bottle of soda: In February 2021, before inflation started to rise, it cost an average of $1.67 in grocery stores across America. Three years later? That bottle goes for $2.25 – a 35% increase.
Or egg prices. They rose in 2022 and then fell again. Yet they are still 43% higher than three years ago.
The same goes for the average used car price, which shot up from about $23,000 in February 2021 to $31,000 in April 2022. By last month, the average had fallen to $26,752. But that’s still a 16% increase from February 2021.
Wouldn’t it be great if prices actually fell – what economists call deflation? Who wouldn’t want to fire up a time machine and return to the days before the economy shot out of the pandemic recession and prices skyrocketed?
In any case, prices are now rising more slowly – which is called disinflation. For example, on Friday the government said a key price gauge rose 0.3% in February, compared with a 0.4% increase in January. And compared to a year earlier, prices rose by 2.5%, well down from a peak of 7.1% in mid-2022.
But those incremental improvements are hardly enough to satisfy the public, whose dissatisfaction with prices poses a risk to President Joe Biden’s re-election bid.
“Most Americans are not just looking for disinflation,” Lisa Cook, a member of the Federal Reserve Board of Governors, said last year. “They are looking for deflation. They want these prices to return to pre-pandemic levels.”
However, many economists warn that consumers should be careful what they wish for. Falling prices across the economy would actually be an unhealthy sign.
“There are,” the Bank of England warns, “more consequences of falling prices than meets the eye.”
What could be so bad about lower prices?
Deflation is a widespread and persistent decline in prices throughout the economy. Occasional monthly declines in consumer prices do not count. The United States has not experienced real deflation since the Great Depression of the 1930s.
Japan has experienced a much more recent period of deflation. The country is only now emerging from decades of falling prices, which began with the collapse of the real estate and financial markets in the early 1990s.
“While lower prices may seem like a good thing,” Banco de España, Spain’s central bank, says on its website, “deflation can actually be very damaging to the economy.”
How come? Especially since falling prices often discourage consumers from spending money. Why buy now when you can buy what you want later (cars, furniture, appliances, vacations) at a lower price?
The reality is that the health of the economy depends on steady consumer purchasing. In the United States, household spending represents about 70% of the entire economy. If consumers were to withdraw en masse in anticipation of lower prices, companies would be under intense pressure to cut prices even further in an effort to boost sales.
In the meantime, employers may have to lay off a slew of workers or cut wages – or both. Unemployed people will obviously spend even less money, so prices will likely continue to fall. All this threatens to create a “deflationary spiral” of price cuts, layoffs, more price cuts and more layoffs. And so forth. A new recession could follow.
It was precisely to avoid that kind of economic woe that explains why the Bank of Japan resorted to negative interest rates in 2016 and why the Fed kept US interest rates near zero for seven years in a row during and after the Great Recession of 2007- 2009.
Deflation also has another painful effect: It hurts borrowers by making their inflation-adjusted loans more expensive.
It is certainly true that Americans can continue to see their salaries rise as prices fall. If food or gas prices were to fall, households would certainly find it less painful to pay for groceries or commuting – as long as they continue to work.
Some economists even question the idea that deflation poses a serious economic threat. In 2015, researchers at the Bank for International Settlements, a forum for the world’s central banks, reviewed 140 years of deflation episodes in 38 economies and came to this conclusion: The correlation between falling prices and economic growth “is weak and largely comes from emerged from the Great Depression.”
But the exception was a doozy: From 1929 to 1933, American economic output plummeted by a third, prices fell by a quarter, and the unemployment rate skyrocketed from 3% to a crushing 25%.
The bank’s researchers said the biggest economic risk did not come from falling prices for goods and services, but rather from a free fall in the price of assets – stocks, bonds and real estate. These collapsing assets could in turn topple banks that hold crumbling investments or that have made loans to troubled real estate developers and homebuyers.
The damaged banks can then cut off lending – the lifeblood of the wider economy.
The likely outcome? A painful recession.
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AP Auto Writer Tom Krisher in Detroit contributed to this report.