Can inflation be too low?

Whenever Federal Reserve Chairman Ben Bernanke speaks, people listen. Recently, he said he and the Federal Reserve would work both to keep inflation from being too high but also to keep it from being too low. How can inflation ever be too low? N.C. State University economist Mike Walden responds.

“Whenever the chairman speaks, we do all perk up. And these remarks actually gathered some attention. Now, clearly people can understand inflation being too high. I mean what inflation does is it increases the cost of living. That means you and I have to earn more to keep up with the higher cost of living.

“We all remember, at least you and I remember the late ’70, early ’80s, when we had inflation in the 11, 12, 13 percent rate. No one could keep up with that rise in the cost of living. So clearly we understand that inflation can be too high.

“But what about too low? Well, I think what Fed Chairman Bernanke was actually talking about was not really low inflation like 1 or 2 percent, but what he would consider to be negative inflation – when prices actually go down – which, again, a lot of people think, ‘Well big, big deal. That’s great. Prices go down.’

“The problem is that usually wages and salaries follow. So that’s a negative.

“Number two, when prices are going down, people tend to wait to buy. They think, ‘Hey, the price is going to be lower later.’ And if people don’t buy in our country, we don’t have an economy. Our economy runs on people buying things.

“And then probably the worst problem emanating from negative inflation is the value of debt and the value of debt payments go up, because debt and debt payments are generally denominated and a certain amount of money, a certain amount of dollars per month – $1,000 a month on your mortgage, for example. So prices are going down. Your salary is going down, and it’s harder to make those payments.

“So, I think that’s what Fed Bernanke, Fed Chairman Bernanke, was talking about. He doesn’t want very high inflation. But he certainly doesn’t want negative inflation either.”