(FORTUNE Magazine) – Wall Street economists and analysts, like some small children, insist on having a bogeymen to scare themselves to sleep with. For many years, the specter of choice has been inflation: whenever things seem to be going too well, someone warns that inflation is just around the corner and there'll be hell to pay. But that's become pretty unbelievable lately, with inflation as low as it's been in a generation and with scant evidence that it will rise anytime soon. So what's Wall Street's newest imaginary monster? It's deflation--the economic condition in which prices, on average, fall consistently, something that hasn't happened in the U.S. since the Great Depression. A few Wall Street analysts--Charles Clough of Merrill Lynch and Gary Shilling, to name two--have been warning that the economy may be heading into deflationary territory, and nervous talk about deflation is becoming commonplace wherever market analysts congregate.

Sustained deflation could in fact be pretty scary. An easy way to think about it is that deflation is the opposite of inflation. It would turn upside down many of our basic beliefs about how we interact with the economy. Prices of goods and services would fall on average over time; cash would increase in value. Companies would feel pressure to cut wages and salaries. A retiree on a fixed income would find himself richer each month. Anyone with debts that are repaid in a stated number of dollars--anyone, that is, with a mortgage or line of credit--would be paying more and more each month in real terms. In the first four years of the Depression prices fell an average of 8% per year, and big chunks of the economy went down with them.

But there is in fact no evidence that we're witnessing deflation today, and very little reason to worry that it will happen in the future. It's true that some prices are falling: The most notable evidence is the producer price index, which measures price changes at the wholesale level and has fallen for seven months in a row. One reason for this is the sharp decrease in the price of computers--which has been going on for years. Another is recent drops in food and energy prices. Another is the strength of the dollar, which makes foreign goods cheaper and forces U.S. competitors to hold down their own prices.

But all the price declines are for goods; service prices have kept right on rising. Goldman Sachs economist Joseph Abate notes in a recent research report that "the softness in goods prices is actually masking extremely stable service price inflation." And services are making up an increasing part of GDP. That's why there is still inflation between 2% and 3% at the consumer level--where it really matters--and why it will continue somewhere near that range for the foreseeable future.

That some prices should be falling is a logical and predictable consequence of the low inflation policy that the Federal Reserve has pursued in the 1990s. If the consumer price index only rises by 2.2%, as it has in the past 12 months--and we know some prices are going up much faster--it stands to reason that others should be falling. Why shouldn't some prices fall, anyway? The closer we get to a state of true price stability--zero inflation--the more this will happen. Even a mild spell of general deflation might not be so bad. The British classical economist Alfred Marshall noted that one effect--so long as companies aren't cutting wages--is to deliver a real raise to workers even if their nominal wages don't rise.

Severe deflations throughout history have occurred in economic circumstances far different from ours: when the economy has been contracting (today it's expanding); when corporate profits are nonexistent (they're robust); and when unemployment is rising (it's falling). All told, the notion that the U.S. economy is entering an age of deflation, says Allan Meltzer--chairman of Carnegie Mellon's business school and a monetary economist of some note--is "utter nonsense."