With Japan as an example, nobody should need reminding that deflation is a uniquely dangerous prospect – but here is a refresher. Persistently falling prices increase the inflation-adjusted burden of debt. Insupportable debts are the core of the US economy's difficulties. If that burden grows even heavier because of falling prices, the contractionary forces will strengthen. The economy will slow further, the deflationary pressure will increase again, debts will become more burdensome, and so on. Since interest rates cannot fall to less than zero, monetary policy cannot follow inflation all the way down. This makes the deflationary circle difficult to break. Nothing is more important than preventing the economy from toppling into it.
Prices in the US fell in October by 1 per cent, the biggest such fall for 60 years. That was an urgent warning – though it does not mean that deflation has arrived just yet. Prices (excluding food and energy) are 2.2 per cent higher than a year ago. Expectations of inflation remain positive, which is crucial since expectations of inflation tend to be self-fulfilling. It would take a stunning and prolonged recession to drive inflation expectations negative, thus pushing the economy all the way over the deflationary edge. But a stunning and prolonged recession may be exactly what the US faces. At the moment, each new economic indicator shows a shocking rate of contraction.
In Ben Bernanke, the Fed has a chief who understands deflation's causes and cures as well as anybody: the subject was one of his specialities as an academic. Since joining the Fed he has given speeches on unconventional tools of monetary policy that can be used when short-term interest rates have been cut virtually to zero: new facilities to improve liquidity; commitments to keep short rates low; “quantitative easing” (expanding the Fed's balance sheet, thus supplying reserves to the banking system), and other measures. Many of these unorthodox tools have already been deployed. What more needs to be done?