Consumer prices in record decline

Inflation falls by a record 1% in October, worrying economists that falling prices will become a disturbing trend.

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By David Goldman, CNNMoney.com staff writer

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Which should be the Obama administration's priority?
  • Stimulating the economy
  • Reducing the budget deficit

NEW YORK (CNNMoney.com) -- Consumer prices fell by a record amount in October, another worrisome sign about the contracting economy, the government reported Wednesday.

The Consumer Price Index, a key inflation reading, fell 1% last month, according to the Labor Department. That was much weaker than September's flat reading and exceeded the 0.8% decline a consensus of economists surveyed by Briefing.com had forecast.

Prices fell by the greatest amount since the Department of Labor began publishing seasonally adjusted changes in February 1947.

"It's a sign of the times in a difficult environment," said Terrin Griffiths, a former Labor Department employee and currently an economist at the California Credit Union League. "Prices rose too much earlier in the year, and now there's a drastic change in the global economic outlook."

The issue of consumer prices has changed dramatically in recent months. For most of the year, inflation driven by high energy prices has caused consumer prices to soar, reaching a 17-year high in July.

Deflation fears

Now, economists are worried about deflation - the opposite of inflation. Falling prices may be a welcome sign for consumers in grocery store aisles and filling up at the pump, but deflation is generally a bad sign for the economy.

"You cannot deny the threat of deflation now," said Griffiths. "We're in an environment where there is a general unwillingness to buy anything."

If prices fall below the cost it takes to produce products, businesses will likely have to cut production and slash payrolls. Rising unemployment would cut demand even further, sending the economy into a vicious circle.

Deflation usually represents a system-wide contraction in demand, with consumers waiting on the sidelines as they wait for prices to decline even further.

But deflation is not yet here, and despite predictions of a long and deep recession, deflation may never rear its ugly head in this business cycle. The 1% fall in October left overall prices 3.7% above where they were 12 months earlier. That's down from the 4.9% rise on that basis in September, and it is the lowest level since October 2007.

"It is very clear disinflation, but it is not deflation," Lakshman Acuthan of Economic Cycle Research Institute told CNN. "That would be persistent price declines. You may be seeing deflation in housing and energy, but what this is, is the silver lining of the recession - lower prices."

Government steps in

Demand for consumer products took a sharp turn downward in recent months as the credit crisis took hold. Consumer confidence fell to an all-time low in October, according to a recent Conference Board study. Consumers would rather save money than spend it, and for those who want to make big purchases, loans have been expensive and hard to come by.

As a result, the government has launched a massive, multi-trillion-dollar financial rescue effort aimed at stimulating lending and boosting the economy. But the global economic climate has taken a sharp turn for the worse since September. The stock markets have fallen drastically, and many experts believe the United States is in a recession.

So now the government needs to worry about monetary policy that both stimulates the economy and boosts lending in order to get consumers interested in buying products again.

"Stimulus, from a monetary perspective, is not really generating the desired results, because everyone is still hoarding money," Griffiths said. "With Obama coming in, the government will need to stimulate from a fiscal perspective, since it's really the labor market that's most impacting consumers."

President-elect Barack Obama has repeatedly stated his support for another economic stimulus package in the form of tax rebates to consumers, states and municipalities. Stimulus checks delivered in the spring of 2008 helped boost consumer spending in the second quarter, but the positive results proved to be only temporary when the credit crisis and economic downturn took hold.

Core inflation falls

The closely watched core CPI, which strips out volatile food and energy prices, fell 0.1%. Economists had expected a 0.1% rise after a 0.1% jump in September. Core CPI posted a 12-month change of 2.2%, down from a 2.5% rise on that basis from the month before.

Food prices actually continued to rise - increasing 0.3% in October - but energy prices fell by a staggering 8.6% in the month.

Core inflation is now at its lowest point since October 2007, but it is still a bit above the perceived comfort zone of central bankers. The Federal Reserve is generally believed to want to see the 12-month change in core inflation readings remain between 1% and 2%.

Economists say falling prices could give the Federal Reserve more wiggle room for lowering interest rates. The Fed cuts its key funds rate to an all-time low of 1% in response to deterioration in global financial system, but those cuts tend to be inflationary.

On Tuesday, a separate Labor Department report showed wholesale prices also fell by a record amount in October as energy costs continued to decline. To top of page

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