For the first time in over a half century, the prices U.S. consumers pay for goods and services are lower on average than they were one year ago.
Still, government price data for March suggest the risk of sustained, broad-based price declines known as deflation remains fairly remote, since the drops are still mostly centered in energy and energy-related products.
Separately, capacity use at U.S. factories fell to a record low in March, reflecting the severe toll the recession is taking on manufacturing.
Core and overall measures of price inflation have fallen considerably, reflecting declines in commodity prices and the emergence of considerable economic slack. We expect core inflation to continue to edge down, reaching 1 percent in 2010. Given the weakness of the U.S. and global economies, the outlook for inflation is highly uncertain. Some Phillips-curve inflation forecasting models based on the view that inflation expectations are unanchored predict a high probability of deflation next year. In contrast, Phillips-curve models based on the well-anchored inflation expectations seen over the past 16 years indicate little probability of deflation and predict inflation rising towards 2 percent over the next two years.
Originally published at the Economist’s View and reproduced here with the author’s permission.