The dangers of deflation

Hundreds of thousands of people are being laid off. The nation’s leading banks and carmakers need bailouts. The stock market has had an ugly 2008.

Well, here’s something else to worry about: deflation. This week, the government announced that prices fell in November for the second month in a row.

It might seem hard to understand what the problem is with falling prices. If all they mean is that we can buy our Christmas presents for less this month than we could have a month ago, maybe we can get the decked out Mac after all. What’s there to worry about?

A lot. If prices persist in their decline, they could be devastating to the economy — not primarily because of their impact on consumers’ spending habits but because of their impact on consumers’ ability to service their debts.

Think of it this way: Say you earn $50,000 a year, and have a $200,000 mortgage. If there is heavy deflation, prices and salaries fall. Your salary might go down to $40,000, but your mortgage would remain the same. Suddenly, making those mortgage payments has gotten a lot tougher.

Read the rest here.