The deflation conundrum

With the U.S. housing market still under duress, commodity prices off sharply, stock prices still floundering, and a lot of sales at the mall, the economic bugaboo “deflation” has been very much in the air lately. The word conjures up any number of nasty images — most immediately, Japan since the 1990s, when the country found itself in a deflationary quagmire and struggled (unsuccessfully, to date) to fix the problem with different policy balms, most famously its zero-interest- rate policy that made the Japanese yen the darling of forex carry traders around the world.

Now the U.S. has a zero interest rate as well, and despite the fundamental differences (for better or worse) in the Japanese and American economies, there is a great deal of speculation the U.S. might be in for some of the same medicine the Japanese have been quaffing for more than a dozen years.

What caused Japan’s economic malaise, and what are the lessons from the country’s so-called “lost decade”?

Although it’s an emotionally charged topic susceptible to extreme forecasts, there are several important points to explore regarding the deflation issue — including the differences between asset deflation and price deflation, as well as disinflation and discounting.

Is the U.S. currently experiencing deflation? Within certain asset markets, such as housing, the answer is a resounding yes. In regard to the stock market, some would argue it isn’t deflation, but a bear market. Commodity prices have come down sharply, which could also fall under the category of asset deflation.

But in terms of classic price deflation — a situation in which prices are declining broadly at all levels of an economy, economists say no, at least not now. However, currently the U.S. is experiencing price disinflation, positive inflation that is getting smaller, but is positive nonetheless.

Let’s look more closely at specific areas of the U.S. economy.