Clothing is 6% cheaper: Here's why Wall Street is watching that and other price drops


Clothing prices were almost 6% cheaper in April, compared with 2019, and while most people weren't traveling, airline fares were down 24%. Still, Wall Street is taking note of falling prices — and some experts are worried about further declines.

The economic damage caused by the coronavirus pandemic included stay-at-home orders that caused demand to slump for certain goods and services. U.S. consumer prices fell the most in April since at least 1957, and the steepest declines were for apparel and transportation services. What's more, this gauge — the consumer price index (CPI) — experienced two straight months of declines, something that hadn't happened since 1982.

CPI is one of a few key gauges used to measure the inflation rate, or how much prices are changing (and usually rising). When the inflation rate drops below 0%, that's called deflation. The CPI report for May is scheduled for release on June 10 and economists currently project that prices held steady when compared with April. 

What is deflation and how does it affect your money?

Video by Stephen Parkhurst

The recent declines in prices, along with the current economic recession, have raised concerns among many people on Wall Street about deflation. They're not alone: In recent months, Google searches for "deflation" jumped to the highest level in five years.

But while it's abnormal for prices to drop in any given month, the fact that it happened for two consecutive months still doesn't necessarily mean deflation has become an economic reality. What's happening now may be what's called disinflation, or a temporary slowdown in prices.

Here's what you need to know about how changes in prices can affect you.

From inflation to deflation

The cost of any particular good or service will dictate how much you can afford, but the rate at which prices are generally changing has a broader impact on your bottom line. For example, you may get a salary increase that's tied to the rate of inflation and whether the Federal Reserve raises or lowers interest rates.

For most of modern history, inflation has been the norm in the U.S., with the most notable period of deflation occurring in the early 1930s during the Great Depression. A general rise in prices is considered good for the economy because that inflation can boost consumer demand for goods and services, in turn leading to broader growth.

However, moderation is key. The Federal Reserve is tasked with helping to maintain a well-functioning economy by keeping an eye on three key goals: maximizing employment, keeping prices stable, and moderating long-term interest rates. 

How the Fed's interest rate decisions impact you

Video by Stephen Parkhurst

Central bankers want to strike a balance between some inflation but not too much. Their long-term target for the inflation rate is 2% and, to help achieve that, the Fed will adjust interest rates when necessary. Policymakers will raise interest rates to keep inflation in check when economic growth is strong and cut interest rates when the economy slows in an effort to stimulate activity by making it cheaper for consumers and businesses to borrow money.

While deflation is uncommon, its presence is considered to be a key difference between a recession and a depression. There was a brief period of deflation during the Great Recession of 2007 to 2009 when consumer prices fell as much 2.1% compared with the prior year, but then prices rebounded. During the Great Depression of the 1930s, by contrast, there was persistent deflation exceeding 10% for more than three years.

Why people are worried about deflation now

Since it's normal to see prices generally increasing, people on Wall Street tend to get a bit spooked by the prospect of deflation. An unprecedented slump in oil in recent months — the price of futures contracts even turned negative in April — along with the threat of an economic slowdown unlike any since the Great Depression have also stoked fears. 

"The Federal Reserve should be more worried about deflation, when prices are falling broadly in the economy, rather than inflation, when prices are rising. If deflation becomes embedded in the economy, it can be difficult to uproot," Gus Faucher, chief economist at PNC, recently told CNBC. "If prices are falling, consumers and businesses may wait to make purchases, assuming that prices will be even lower in the future; this can exacerbate economic downturns."

If deflation becomes embedded in the economy, it can be difficult to uproot.
Gus Faucher
chief economist at PNC

Disinflation, or a temporary slowdown in the pace of inflation, is more likely to be what's going on right now than deflation, according to a BofA Global Research report. The bank forecasts that the unemployment rate "will likely get stuck close to 10% for some time" in the aftermath of the coronavirus shutdowns and reopening efforts. 

"This is a recipe for disinflation," the BofA economists wrote, adding that they forecast the core rate of inflation to reach 0.6% by the end of the year. "We think we will avoid outright deflation in underlying inflation and that the focus will be on measures of expectations."

Changing prices and how much you can afford

When prices go down, your dollars go further when you're buying groceries or paying for services. Even so, lower prices can be a sign of persistent deflation, and that will be one of the indicators that economists watch to indicate the severity of the economic recession.

More broadly, however, you don't need to worry so much about the current pace of inflation. Instead, focus on how to ensure you make smart decisions no matter what the current inflation rate is. That includes negotiating your salary, opening a high-yield savings account to ensure that inflation doesn't erode the value of your savings, and capitalizing on the incentive to invest your money in the market to grow your wealth.

More from Grow: