Most Americans are happy that the price of oil has tumbled, helping consumers while hurting nasty regimes abroad. There are always worriers among us, though, and what has them alarmed today is that this decline will tip the U.S. into a damaging round of deflation. There's no need to join them in their gloom. Deflation isn't something we should fear.
What matters is what's causing prices to decline: an increase in productivity or a decline in economic activity. Only in the second case is there a serious danger that the Federal Reserve should try to respond to. Similarly, rising prices can be a sign that monetary policy is too loose, but can also reflect declines in productivity.
And so changes in the price level, or prospective changes in it, can easily lead central banks astray. A run-up in oil prices, much of it caused by supply disruptions, made the Fed excessively concernedabout inflation in 2008, which is one reason it was slow to react to the financial crisis. (When Lehman Brothers Holdings Inc. collapsed that year, the Fed was so concerned about inflation that it initially declined to cut interest rates.)
The current fall in the price of oil is creating a bias in the opposite direction. It's stirring up fears of deflation and leading to calls for looser monetary policy. This reaction is less likely to prove catastrophic than the error of 2008. But it is still an error. If inflation expectations are falling because markets expect the Fed to run an excessively tight policy over the next decade, or predict a long depression, it's a reason to loosen monetary policy. If they're falling because markets expect more abundant energy, on the other hand, it's just a reason to celebrate.
There are, however, two wrinkles worth noting. One is that although the fall in the price of oil doesn't appear to reflect any weakness in the U.S. economy, weakness abroad may be a factor. But that's a reason to loosen money elsewhere, not in the U.S. A second is that there is areasonable argument that monetary policy in the U.S. has been a little too tight even leaving aside this price decline. If that's correct, then some added pressure for loosening, even if that pressure is based on a mistaken worry, might not be such a bad thing.
If money has indeed been too tight, then it might not be a bad thing for fear of deflation to exercise a countervailing pressure on the central bank. That fear, however misguided, might make the Fed less likely to raise interest rates prematurely.