The attention of policymakers and economists is trained mostly on a looming inflation threat, the drawback you typically associate with enormous amounts of liquidity pumped into the financial system and an economy rebounding from a severe recession. A negligible 0.1% rise in the March consumer price index and comments from the Federal Reserve that interest rates will remain very low for an extended time don't appear to confirm that risk, however.
Some economists and analysts see reasons to worry about the opposite scenario—a period of deflation if companies feel compelled to lower prices to jump-start demand in a sluggish economic recovery burdened by high unemployment. Consumers initially embrace falling prices, but if it becomes deep and pervasive enough, deflation will eventually push employers to cut wages and ax jobs, driving worried consumers into complete retreat. Perhaps most dangerous, deflation hikes the cost of repaying debt by boosting the value of the dollar.
That the value of the U.S. dollar is down 30% from its peak several years ago should have been sufficient to restore the U.S. to a fairly competitive trade position, even given the euro's recent decline, says Barry Bosworth, senior fellow at the Brookings Institution in Washington. But U.S. exports, which were robust in the first half of 2009, have disappointed since then. "For the U.S. to have a positive outlook, we have to have an export-led economy," he says. "We can't expect [domestic] construction to come back any time soon."
Strictly speaking, we're in a period of disinflation, defined by a decline in the rate of inflation, says Joseph Trevisani, chief market analyst at FX Solutions, a currency brokerage in Saddle River, N.J. Historically, prices were relatively stable for long periods and a moderate level of inflation is a modern development, he says.
Deflation, a drop in prices over a certain span of time, signals "a damaged or seriously problematic economy," he says. Disinflation increases the possibility of actual deflation occurring since any rise or fall in prices has to be seen on a continuum, Trevisani adds.
While some of the optimism about growth in the U.S. economy is justified and business conditions have improved over the past year, there isn't sufficient evidence yet to suggest the economy will be booming a few years from now, says Bosworth at Brookings.
"Unemployment will be a severe overhang for prices in the U.S.," he says. "We may have some pass-through in energy prices [that boosts consumer prices generally], but I can't see the labor market righting itself in the near future."
Bosworth sees no sign of pricing power in either the labor or the product markets. U.S. companies have been able to maintain high profit margins due to increased productivity and cost-cutting, not higher prices, he says.
A dearth of new construction projects is preventing manufacturers from regaining any pricing power, says David Gordon, a principal at Channel Marketing Group, a marketing consulting firm that advises manufacturers, distributors, and industry associations. With so much slack in the construction industry, distributors are going after the few scraps of business they see and are so focused on capturing market share that they're willing to give up pricing power, he says.
The plumbing, building materials, and electrical supply companies he works with aren't even passing through higher fuel and other commodity costs to their customers, he adds.
David Huether, chief economist for the National Association of Manufacturers, cites diminished pricing power in sectors related to housing—nonmetallic minerals such as cement, bricks, and glass, as well as furniture makers. But food and chemical manufacturers, which together make up more than 27% of the manufacturing sector, have been able to raise prices over the past year.
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