The Winds of Deflation

By Robert Reich, Robert Reich's Blog

18 September 10

hree economic reports today (Friday) that should sound warning bells about deflation.

1. The Labor Department reports that consumer prices are essentially flat. Compared to August 2009, prices are up 1.1 percent. That's only slightly lower than the 1.2 percent year-on-year rise in July. Excluding volatile food and energy, however, consumer prices in August were 0.9 percent higher than a year earlier. That's below the Fed's informal inflation target of between 1.5 percent and 2.0 percent.

2. In a separate report, the Labor Department said real average weekly earnings were unchanged in August from July, as both the average work week and hourly earnings were flat.

3. The Thomson Reuters/University of Michigan September reading of consumer confidence shows consumers more pessimistic in September than in August. In fact, consumer sentiment is the lowest since August 2009.

Put the three together and you have what could be a recipe for deflation: Flat consumer prices, weekly earnings, and hours, coupled with increased pessimism about where the economy is heading.

Consumers aren't buying. They're acting rationally. Their debt load is still huge, they're worried about keeping their jobs, they know they have to tighten belts, and they're justifiably worried about the future.

But for the nation as a whole, it spells even more trouble. If consumers hold back even more, prices will start dropping. When and if they do, consumers will hold back even more in anticipation of still lower prices. That means more layoffs and less hiring.

It's a vicious cycle. And once deflation sets in, it's hard to reverse. Just ask Japan.

Robert Reich is Professor of Public Policy at the University of California at Berkeley. He has served in three national administrations, most recently as secretary of labor under President Bill Clinton. He has written twelve books, including "The Work of Nations," "Locked in the Cabinet" and "Supercapitalism." His upcoming book, "AFTERSHOCK: The Next Economy and America's Future," is due out in mid-September. His "Marketplace" commentaries can be found on publicradio.com and iTunes.