Why ultra-low inflation can hold back the economy

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Associated Press

Posted on February 19, 2014 at 6:35 PM

Updated Wednesday, Feb 19 at 6:36 PM

Historically low inflation has taken hold across the developed world, from the United States to Europe to Japan.

Economists say super-low inflation has likely slowed growth in those regions, which is why the world's central banks would like prices to rise.

Last year, overall U.S. prices inched up just 1.1 percent, according to the Federal Reserve's preferred gauge. Inflation has stayed below the Fed's 2 percent target for two years. It's even lower in Japan and Europe.

So why is very low inflation bad for the economy? Isn't it helpful when prices stay low?

Not when they barely budge. Here are some reasons:

— When prices barely move, many people postpone purchases. Why rush, if the same price — or lower — will be available in six months? Collectively, these delays slow consumer spending, the economy's main fuel.

— Too-low inflation raises the prospect of deflation — a broad decline in prices, pay and the value of stocks, homes or other assets. Deflation can further restrain spending and even tip an economy into recession.

— Retailers engage in harmful price competition. Big chains such as Wal-Mart, Best Buy and Bed, Bath & Beyond, for example, fought a brutal price war during the past holiday shopping season. Thirty-three retail chains cut their profit estimates for the final months of 2013, according to RetailMetrics LLC..

— Low inflation leads many businesses to hoard cash. Higher inflation, by contrast, would erode the cash's value. So businesses would be more inclined to spend — to hire or buy equipment.

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