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The economy certainly has no shortage of problems, with the past month seeing disappointing reports on housing starts, and sales of new homes and existing residences; less-than-stellar reports on manufacturing and non-manufacturing activity; weak job creation levels and persisting high unemployment; sluggish retail activity; and lackluster gains in industrial production and factory utilization. Clearly, the economy is stumbling, and expectations for the recently ended second-quarter gross domestic product are fading fast. Once, we believed that growth would approach 4% in the period, and at least one forecasting group saw GDP rising by nearly 4.5%. Now, our sense is that growth the quarter may have struggled to even reach 3%. Moreover, we are even less optimistic about the second half, fearing that growth may have to struggle just to approach 2.5%.
 
However, there is one good story out there. That is inflation, which continues to be stubbornly held at bay. For example, in a report issued yesterday, the U.S. Labor Department reported that producer prices (wholesale inflation) dipped by 0.5% in June, led by lower food prices. The core PPI reading, which excludes the volatile food and energy components, rose by just 0.1%. Obviously, there is no inflation outbreak at the wholesale level. Now, this morning, Labor reported that the companion Consumer Price Index declined by 0.1% in June, following declines of 0.2% and 0.1%, respectively, in May and April. In fact, we need to go back to January of this year to find a CPI reading that exceeded 0.1% on the upside. And that month saw prices increase by just 0.2%. Not only is inflation subdued, but it has been so for some time. Finally, the core rate of CPI growth was a nominal 0.2%.
 
Now, while there is no inflation problem, what about disinflation or deflation? Disinflation, by definition, is the reversal of inflationary pressures, or more directly, the near-absence of inflation. Put another way, disinflation can be characterized by slowing, but still positive, inflation. It is a rare occurrence, except during some periods of economic stagnation or recession. We appear to be in such a period now, with inflation generally slowing or disappearing in some months. Disinflation is not necessarily a positive, since, as noted, it is usually accompanied by faltering economic activity, such as we currently are experiencing. Moreover, we could face more of the same in the second half, when both economic growth and inflationary pressures may be less than had been expected earlier.
 
On the other hand, deflation, or actually declining prices, is a decided negative. The last time we saw such a sustained event was during the Great Depression of the 1930s. It is the fear of such a downturn in prices and the shrinkage of economic activity that has kept the Federal Reserve so careful in not raising interest rates over the past year, even as economic growth, however fragile, has returned.
 
Is disinflation or, worse, deflation, on the horizon? We think there is a fairly good chance of the former. In fact, in a limited sense, we now have disinflation, although the latest CPI report did show sizable increases in prices for cars, apparel, and medical costs. As for deflation, we think the risks are less, but cannot be dismissed totally, In fact, in a recent interview, the head of the Boston Federal Reserve, Eric Rosenfren opined that the risk of deflation had risen and ``is more of a risk than I would like to see at this point.'' The head of the Atlanta Fed also chimed in with his concerns, and said it would be appropriate for the central bank to consider what it would do in such an environment.
 
These are clearly sobering thoughts. So for those cheering the near-absence of inflation, we would encourage them to go back to the history books. A study of the Great Depression could be instructive.