Cheap oil and low inflation -- sounds like a dream come true, right? Yet in economics, dreams have a way of turning into nightmares.
A sudden bout of deflation is the latest threat to the recovery of rates on savings accounts and other deposits. Recent months have seen the Consumer Price Index reverse from a slow rise to a decline. Meanwhile, the Producer Price Index recently turned negative for the first time in more than a year. Oil prices have been routed. The spot price for a barrel of oil fell from more than $100 in late July to the $80s by mid-October.
Bringing price increases under control has long been the goal of central banks and governments. However, when prices turn negative, it can be a sign of fundamental economic problems.
What's causing the inflation slowdown
One factor in the recent shift toward deflation, aside from sinking oil prices, is a strong dollar. But then, it may be more accurate to say that other currencies have been weak.
The economy of Germany -- perhaps the most reliable European economy in recent years -- may already be in a recession, and Japan's economy could be headed the same way. Even supposedly fast-growing developing economies are in trouble. Growth in Brazil has stalled, analysts are wondering how long China can keep up the illusion of steady high growth, and Russia's economy is bound to suffer from the decline in oil prices.
As for the U.S., the effect of all this can be seen from a recent Bureau of Labor Statistics report on import and export prices. Import prices have declined by more than 1% over the past two months due to the strength of the dollar. That is helpful for American consumers, but it represents lost income to struggling foreign economies. Meanwhile, export prices have also dropped in four of the last six months, representing lost revenue to U.S. exporters.
Implications for savings accounts
In the short term, savings accounts will see some benefit from falling prices. Deflation means that the dollar instantly gains some purchasing power. This might seem like a fitting turnabout for savings accounts, which have steadily lost purchasing power in recent years as interest rates trailed inflation.
The problem is that this all comes in a context of deteriorating growth. Whereas just weeks ago there was talk of how soon the Federal Reserve would raise interest rates, the primary concern now is that a weak global economy and an overly strong dollar might force the Fed to keep rates low longer than expected.
Most savers need income. It is not enough for savings accounts to simply tread water over the long run; they need to be able to earn a decent rate of interest. Steady growth with moderate inflation was the ideal formula for restoring interest to that level. A destabilizing bout of deflation amid global economic weakness is a step in the wrong direction.
This article originally appeared on money-rates.com.
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