The fear of deflation

We're used to worrying about inflation. Those of us of a certain age can recall what it was like, and what it was like to make it go away -- can anyone remember when a 12 percent mortgage sounded like a good deal?

Now, however, people in the know are worried about the opposite: deflation, a decrease in prices. The economist Nick Perna writes:

Deflation can be a nightmare. As prices fall, the incentive to postpone purchase grows and further weakens the economy. Lenders struggle as the value of loan collateral erodes and the ability of borrowers to repay weakens. Meanwhile, the loan amount stays the same in dollars.

Astoundingly, he says, The Federal Reserve Board "is actually worried that inflation is too low."

To get an idea of why, we can look at Japan, which has suffered a deflationary spiral for several decades. Here's a picture of their price trend:

What is life like in deflation? It's not pretty. The New York Times describes what it's like in Japan.

Just as inflation scarred a generation of Americans, deflation has left a deep imprint on the Japanese, breeding generational tensions and a culture of pessimism, fatalism and reduced expectations. While Japan remains in many ways a prosperous society, it faces an increasingly grim situation, particularly outside the relative economic vibrancy of Tokyo, and its situation provides a possible glimpse into the future for the United States and Europe, should the most dire forecasts come to pass. 

Here are some numbers.

• Japan’s economy remains the same size it was in 1991; during the same period, the United States economy doubled in size.
• Companies and individuals have lost trillions of dollars in the stock market, which is now just a quarter of its value in 1989.
• The average price of a home is the same as it was in 1983.

The psychology effect is great, The Times says: "Deflation has left a deep imprint on the Japanese, breeding generational tensions and a culture of pessimism, fatalism and reduced expectations. While Japan remains in many ways a prosperous society, it faces an increasingly grim situation, particularly outside the relative economic vibrancy of Tokyo, and its situation provides a possible glimpse into the future for the United States and Europe, should the most dire forecasts come to pass"