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By HaleStewart March 19, 2014 5:16 pm
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Fed Acknowledges Potential Deflation Problem

There are already many commentaries regarding Chairman Yellen's first Federal Reserve press conference.  I simply want to highlight a point that will probably be overlooked: the heightened deflationary threat to the US.  Consider the second paragraph from the Fed's policy announcement:

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace and labor market conditions will continue to improve gradually, moving toward those the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for the economy and the labor market as nearly balanced. The Committee recognizes that inflation persistently below its 2 percent objective could pose risks to economic performance, and it is monitoring inflation developments carefully for evidence that inflation will move back toward its objective over the medium term.

The problem with deflation is this: when consumers and businessses see prices either not moving higher or moving lower, they put off purchases, anticipating either consistent prices (It will be the same price when I buy it later this year) or falling (it will probably be cheaper when I buy it).  In either situation, the velocity of economic activity slows.

Consider these charts.


The year over year percentage change in CPI has been fluctuating between 1% and 2% for a little over a year.  And before that, price pressures were clearly decreasing.

For four of the last twelve months, the year over year percentage change in PPI has been negative.  And the number has only been year 1.5% in three of those months.

The point of the above charts is this: they indicate the Fed's concern about potential deflation is reasonable.

Hale Stewart is a former bond broker who has been writing about economics and financial markets since 2006 on the Bonddad Blog.  He is also a tax attorney with a domestic and international practice while also forming and managing captive insurance companies for US companies.   You can follow him on twitter at:@captivelawyer



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