ANALYSIS
A smidgen of inflation could help

By Rachel Beck
Associated Press

NEW YORK — Whenever there's talk about inflation, it's usually about how higher prices can hurt the economy.

But maybe a bit of inflation right now wouldn't be such a bad thing.

That's not to say that there should be hope for consumer prices to skyrocket for a prolonged period of time. But a slight rise in inflation could help stimulate the economy and pull it from a possible deflationary slump.

"A little inflation is like grease in the engine that keeps the economy humming, while deflation is like throwing sand into it," said Sung Won Sohn, an economist at Wells Fargo & Co. in Minneapolis.

Inflation isn't a problem right now. In fact, some economists say the low inflation rate, which has been trending around 2 to 2.5 percent over the past year, exemplifies disinflation — or a slowdown in price increases.

It's true that some possible inflationary pressures, namely higher oil prices, do exist and could become a more serious threat if they linger through the next year.

But the focus today is on deflation, and how to stem the damaging economic effect that falling prices could cause.

Deflation works like this: A weak economy forces businesses to lower prices, and that spurs consumers to hold back on spending because they think even better deals are on the way. Then businesses cut prices even more to stimulate demand, which in turn lowers profits.

During the holiday season, retailers had to slash prices to get consumers to buy. The same has gone on with auto sales.

While economists are divided on whether widespread deflation is even a risk, Federal Reserve officials have talked about the possibility of deflation emerging and the importance of fighting it.

That's where inflation comes in.

"Our levered American economy requires at least a modicum of inflation in order for it to continue to function as we have experienced it," wrote Bill Gross, who runs Pacific Investment Management Company's Total Return Fund.

The Fed has pushed down short-term interest rates so much — its 12 rate cuts over the last two years have left rates at 40-year lows of 1.25 percent — that there isn't much more that it can do.

The government, therefore, may have to turn to other means to get the economy going again.

An option often talked about these days is reflation. That is when money is pumped into the economy by a range of monetary and fiscal policies, including tax cuts.

But there are also risks. If too much money is put into the economy, it could spur bigger-than-expected price gains.

"As things begin to pick up, you have to be cautious because you don't want to rekindle deep-seeded inflation," Stone said.

It's not often that you hear inflation talked about as the answer to any economic problem.

At this moment in time, it may very well be.