NPR

You're Enjoying Low Gas Prices, But Is It Really A Good Sign?

Macy Gould shared this photo from Lexington, Ky., where the gas prices are under $3. (Instagram)

All around the country, gasoline prices have been falling for weeks, down to an average of about $3 a gallon. Those lower prices are helping restrain inflation across the board.

On Wednesday, the Labor Department said its consumer price index barely inched up 0.1 percent last month. Over the past 12 months, the CPI has risen by 1.7 percent, roughly half of its historical average rate of increase.

That sounds great for consumers.

But some economists see possible trouble ahead. They worry that if energy prices were to keep sliding, the process could contribute to deflation — a brutal cycle of falling prices last seen in this country during the Great Depression of the 1930s.

Economists consider deflation to be the nightmare scenario. To understand why, imagine you own a factory. To make your product, you first must purchase parts and raw materials. You promise workers a certain wage. You borrow money to expand.

All of these transactions are based on the idea that you will be able to sell your goods at a particular price. But what if prices start falling?

Suddenly, you can't afford to repay your loan or live up to your contract with workers. You can't afford the parts that already are sitting on your inventory shelves. You have to start selling products at a loss, even as your competitors are slashing their prices.

The downward pressure creates a vicious cycle that quickly leads to a broad plunge in the value of businesses, homes and other investments. While inflation can be painful and corrosive over time, deflation can crush an economy like a boulder out of the sky.

So where is the downward price pressure coming from today? Look overseas.

In both Europe and China, growth is weak. When consumers and companies in other countries start cutting their purchases of energy and goods, then global prices fall.

All over the world, central bankers and policymakers are trying to stimulate growth to keep prices from falling further. In this country, the Federal Reserve, which sets the direction of interest rates, wants to see the inflation rate hold steady at 2 percent.

"Given the deflationary winds blowing our way from Europe, the Fed is going to want to see CPI much higher" before boosting interest rates, Jonathan Lewis, the top investment officer at Samson Capital Advisors, said in an analysis.

For most Americans, here's what all of this means: Wages and prices are not moving much, and interest rates are remaining low. There may be a danger of deflation lurking just over the horizon, but so far, the drop in energy prices has been a boost for consumers.

Many are applauding the pleasures of low inflation. For example, they can buy a car with a cheap loan and then fill it up with cheap gas. That can help stimulate the economy in this country by increasing travel and consumer purchasing power.

"I'm on a very tight budget," said Macy Gould, a Lexington, Ky., resident who graduated from college in May. She was thrilled this past weekend when she was able to refuel for about $2.83 a gallon. "Spending less on gas is a real help to me," she said.

Earlier this year, a driving trip she wanted to make to St. Louis "just wasn't doable," she said. Now that the cost of gas is down so much, "I'm hoping I can get that back on the calendar."

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