For October 2008, there was good news on the inflation front in both the United States and Canada. The year-over-year change in the all-items Consumer Price Index (CPI) in the U.S. dropped from 4.9% the month before to 3.7% and, in Canada, it fell from 3.4% to only 2.6%. Core inflation in the U.S. fell to 2.2% and held steady in Canada at 1.7%.

Low Inflation permits Low Interest Rates

This is what central bankers had been anticipating. This expectation had allowed them to drop interest rates to exceptional lows − 1.00% for the federal funds rate by the U.S. Federal Reserve and 2.25% for the overnight rate by the Bank of Canada − in all good conscience, without worrying about an immediate negative (i.e., upward) impact on inflation.

However, in the opinion of some, the news on the inflation front may be too good. The rate of price increase across a wide spectrum of goods and services is falling substantially as a result of the slowdown in the worldwide economy and other factors as outlined below and this is raising concerns about the possibility of generalized "deflation".

Deflation is Bad for the Economy
Deflation is bad for the overall economy because it contributes to a downward cycle of consumer spending and business activity levels. Consumers hold off on spending in the expectation that prices will drop some more. This causes additional declines in production levels and more job losses, leading to a further spiraling down of spending and prices.

Other Evidence of Deflation
There is considerable evidence of weakening prices throughout the economy, beyond what has just appeared in the Consumer Price Index. Home prices have been falling for a long time in the U.S. and are moderating in Canada as well. Automobile prices have been flat for years, particularly after factoring in all the incentive packages.

De-leveraging by the banks has removed a great deal of capital from the world's wealth storehouse. If inflation is "too much money chasing too few goods", then the first part of that equation has been altered by the world financial crisis and credit squeeze.

Going forward, another contributing factor to falling prices is likely to be the excess industrial capacity that is accumulating in China, due to the cutback in that nation's export sales. Finally, the bursting of the commodity price bubble this past summer has lowered the input cost for almost all materials, since commodities − agricultural, metallic and mineral and energy-related in nature − are their building blocks.

Marveling at the Price Bargains
Few would have ever thought that the world price of oil would drop below $50 USD per barrel again, after it reached $147 USD per barrel in mid-July. Longer-term, inflation is likely to be the greater problem rather than deflation, due to the prodigious stimulus that governments around the world are supplying. However, in the short-term, many of us will be standing back and marveling at all the price bargains that are coming our way.