New Worries About Deflation

If there’s a silver lining in the latest minutes of the Federal Reserve’s June meeting, it’s that we don’t have to worry much about inflation.

But deflation is another matter, creating a whole new set of headaches for policy makers, homeowners, consumers and investors. How do you protect yourself from the prospect of falling prices and shrinking paychecks?

Minutes from the Fed’s June 22-23 Open Market Committee meeting said “a few participants cited some risk of deflation,” but also noted others disagreed. However, it was the first time in a year that the possibility of deflation was mentioned at all. Generally, committee members agreed that the economy won’t grow as fast as they had expected earlier.

Most people are more accustomed to worrying about inflation (when prices rise). Normal inflation levels of around 2% or 3% a year are generally seen as benign. In fact, they can even be good. As your income gradually goes up your mortgage payment gets easier and easier to handle, for instance.

Of course, extreme inflation can be terribly damaging. It makes it less and less likely your retirement savings will cover the ever rising cost of living, for instance.

Certain types of deflation are beneficial, like the gradually falling prices of computers and other electronics equipment. But serious, across-the-board deflation can be as destructive to wealth as rampant inflation.

The best, most current example of that is in the housing market. Millions of people who bought homes in the middle of the decade now find their properties are worth 20% less than the purchase price, and in some formerly soaring markets home prices have fallen by more than half. But the loans taken out to buy these homes are still as big as they were. Experts say about one in four homeowners with a mortgage now owes more than the property is worth.

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