Inflation Remains Tame: Consumer Prices Fell 0.2% in May
Excluding the volatile food and energy components, prices rose just 0.1% in May. Overall, inflation for the past 12 months is running at 2%, but again, excluding food and energy, the CPI has risen at a glacial 0.9% pace over the past year. That shallow rate might sound like a positive for consumers, but economists see it as coming too close to deflation -- something Federal Reserve policymakers would strongly prefer to avoid.
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 revenues, prompting layoffs, which lead to further consumer spending declines, prompting more price cuts, and so on.
Deflation took hold hold during the Great Depression of the 1930s and deepened the era's economic crisis.
U.S. Fed Chairman Ben Bernanke, a former Princeton University economics professor whose areas of expertise include the Great Depression and its causes, is well aware: Inflation is bad for the economy, but deflation is worse.
The Roller Coaster Ride of Energy, Food Prices
So far, deflation is not widespread -- the CPI's decline in May is more a function of those volatile food and energy prices. Energy prices fell 2.9% in May, including a 5.2% plunge in gasoline prices and a 1.4% decline in fuel oil. Natural-gas also fell 1%, and electricity declined 0.4%. Energy prices also fell 1.4% in April. Food prices were unchanged in May.
Both food and energy prices are trending lower after rising during the initial part of the year. Even so, energy prices are still up 14.7% and food prices have risen 0.7% so far in 2010.
Outside of the food and energy categories, most areas of the U.S. economy exhibited low inflation in May, but a few have recorded significant price hikes. For example, with fewer Americans able to purchase new cars, demand -- and prices -- for used cars have surged. Used-car prices were up 0.6% in May, and have jumped 16.2% so far in 2010. Transportation services rose 0.4% in May and are up 4.3% this year. Medical care service prices, unchanged in May, are up 3.4% so far in 2010.
Otherwise, May's inflation report shows little significant upward price movement. Apparel costs climbed 0.2%, education costs rose 0.2%, shelter costs rose 0.1%, and new vehicle prices increased 0.1%.
Remaining on Guard
For now, the general price picture in the U.S. is one of low inflation, and the risk of deflation exists. The caveat, as always, is energy: A sudden, sustained spike in oil prices could cause inflation to surge higher, due to the large role oil plays in the U.S. economy,
Slackness in the labor force will likely keep wage increases contained, and the nation's industrial sector is still operating well below capacity -- two things that should help contain prices at the producer level. Factor in the possibility of an economic slowdown in Europe that could cut into U.S. exports, and demand could dip further, perhaps triggering deflation, so the Fed will remain on guard against both deflation and inflation in the quarters ahead.