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Inflation Slowdown a Worry

With price increases running at the slowest pace in decades, deflation has become a bigger threat to the struggling U.S. economy.

But many economists say the danger of widespread price declines, which undoubtedly would bring the economy back into recession, is still extremely small.

After rising 1.7% in 2002, inflation is increasing less than 1% this year, according to the government's personal consumption expenditure price index. The gauge, favored by the Federal Reserve, tracks prices based on consumer spending, excluding volatile food and energy costs. That measure hasn't been under 1% since 1949.

The inflation drop has been led by slower gains in costs of medical care, which have risen in double-digit proportions in recent years; long-lasting durable goods, which include furniture and computers; and homes.

Such data led Fed officials to warn Tuesday that a "substantial" inflation drop from the current level was possible, although they deemed the chances of that happening as "minor." Private economists agreed with the Fed's assessment, pointing to rising prices for some raw materials, a fall in the value of the dollar and expectations for stronger economic activity later this year, all of which historically have led to price gains.

Lakshman Achuthan, managing director of the Economic Cycle Research Institute, says the group's gauge of future inflation has begun to fall after swiftly rising last year and into the early part of 2003 but still points to further price gains, not declines. The measure looks at a host of inflation indicators.

Despite expectations deflation won't happen, Fed officials are wise to be cautious in light of the recent experience in deflation-mired Japan, economists say. That has shown falling prices can be harder to combat than inflation and can cause serious harm to an economy. The Fed has carefully studied the experience in the world's second-largest economy, which has been in and out of a recession for more than a decade.