WASHINGTON — Consumer prices tumbled again in December, and inflation last year logged its smallest advance since the early 1950s, fanning new fears that the country may face a dangerous bout of deflation.
Worries about out-of-control price increases -- which had gripped the Federal Reserve and the country just seven months ago -- are now a distant memory. Some wonder in hindsight: Should the Fed have kept cutting interest rates all last year to help the recession-shocked country, rather than stopping in the summer and early fall out of concern that lower rates would spur inflation?
The Labor Department's latest inflation report, released Friday, showed consumer prices dropped 0.7% in December, marking the third straight month prices fell.
For all of 2008, prices inched up 0.1%, the smallest increase since 1954. Although prices spiked during some summer months -- as oil hit record highs and food prices marched upward -- the inflation threat of 2008 ended up fizzling.
And that's a dose of welcome news to the strained pocketbooks of American consumers, who have cut back sharply on spending as jobs vanish, home values tank, and investment portfolios dwindle amid a recession, now in its second year.
Average weekly earnings of U.S. workers, after adjusting for inflation, rose 2.9% last year, a big improvement from 2007 when earnings fell 1%, the government report showed.
Economists expect prices will continue to fall over the next several months. For all of 2009, some economists said it's possible prices will be flat or dip.
Falling prices sound like a gift at first -- at least to consumers. But a widespread and prolonged decline can wreak more havoc on the economy, dragging down Americans' wages, and clobbering already-stricken home and stock prices.
Dropping prices already are hurting businesses' profits, forcing them to slice capital investment and lay off workers.
"I think deflation is setting in," said Mark Zandi, chief economist at Moody's Economy.com. "Given the sliding economy, businesses are under extreme pressure to lower prices to maintain sales."
Stripping out volatile food and energy prices, "core" inflation was flat in December. For 2008, it rose just 1.8%, the smallest increase since 2003.
Although chances remain slim that the country will get caught in such a downward price spiral, the mere whiff of deflation is a concern for economists and some at the Fed.
"Some members saw significant risks that inflation could decline and persist for a time at uncomfortably low levels," recently released documents of the Fed's closed-door meeting in December revealed.
At that time, the Fed took the unprecedented step of slashing its key interest rate to between zero and 0.25%, an all-time low. It signaled rates would stay at those levels for some time to help revive the economy.
Many economists predict the Fed will keep rates at record lows at its next meeting Jan. 27-28 and probably through the rest of this year. Doing so also would help fend off any deflationary risk, economists said.
America's last serious case of deflation was during the Great Depression in the 1930s. Japan was gripped with deflation during the 1990s, and it took a decade for that country to overcome those problems.