Consumer Prices Fall -- and May Keep Falling. Deflation, Anyone?

With mall traffic sluggish and Americans still in a frugal mood, retailers are cutting prices -- and that's one reason inflation at the retail level remains low.

Consumer prices fell a seasonally adjusted 0.1% in April, the first drop since March, 2009, the U.S. Labor Dept. said. A decline in prices at shopping malls played a part in that dip -- apparel prices fell 0.7%, and household furnishings declined 0.5%.

What's more, April's 0.1% dip means inflation over the past 12 months is running at a 2.2% rate.

Low Inflation, Outside Energy

That may sound somewhat high, but when the often-volatile food and energy component is eliminated, prices have risen just 0.9% in the past 12 months -- a 44 year low.

Moreover, the impact of sky-high energy prices on the top-line CPI figure may begin to reverse, if May's decline oil prices is sustained. In the 12 months through April, energy prices surged 37% -- gasoline is up more than 38% in that time and fuel oil is up 28% -- and those price increases created the impression that the 2.2% inflation increase was occurring throughout the U.S. economy.

It wasn't: A lot of it was due to double-digit increases in those energy commodities. In addition to the price declines in apparel and household items, over the past 12 months shelter prices have fallen 0.7%, while new vehicle prices are up just 1.2%. What's more, gasoline prices fell 2.1% in April and fuel oil declined 2.4%, and if those downtrends continue, energy's upward skew of the top-line CPI statistic will fade.

So, the U.S. inflation rate is low -- and is likely to become even milder if the recent decline in oil prices persists.

Inflation Is Bad, Deflation Is Worse

In fact, given the existing 0.9% core inflation rate over the past 12 months, modest demand in the U.S. due to the high 9.9% unemployment rate, and the possibility of reduced demand from Europe stemming from the sovereign debt crisis, deflation could occur.

Deflation, a protracted, systematic decline in prices, robs companies of revenue and can lead to the dreaded "deflationary spiral," in which price cuts lead to lower corporate revenue, prompting more lay-offs, leading to further consumer spending declines, prompting more price cuts, and so on.

Deflation took hold hold during the Great Depression of the 1930s and made the downturn worse.

U.S. Federal Reserve Chairman Ben Bernanke, a former Princeton University economics professor whose specializations included the Great Depression and its causes, knows the pitfalls of wage/price movement: Inflation is bad for the economy, but deflation is worse.

U.S. Impact of Europe's Crisis

True, there are some areas of the U.S. economy that have experienced price rises over the past year. Used car prices, boosted by irregular demand from individuals who are not buying new vehicles due to tight budgets, are up about 17% in the past year. And medical care costs also are up 3.7% during that time.

But the general U.S. price picture is one of low inflation -- and the risk of deflation exists. The nation is already experiencing tepid demand amid high unemployment. What's happening in Europe will probably decrease demand further in the U.S. -- putting more downward pressure on prices. That's why Bernanke's Fed will no doubt be preparing policies to guard against the possibility of both deflation and inflation in the quarters ahead.