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The Fed isn't worried about inflation. But should it worry about deflation?

Federal Reserve Board Chairman Ben Bernanke speaks during a news conference after a Federal Open Market Committee (FOMC) meeting December 18, 2013 at the Federal Reserve in Washington, DC. The Federal Reserve has announced that it will scale back its U.S. Treasury bonds and mortgage-backed securities buying program to $75 billion each month.

The Federal Reserve handed a gift to investors yesterday by ending some of the uncertainty about interest rate and stimulus policy. The Fed's extra buying of bonds to stimulate the economy will be tapered back by about $10 billion dollars, or 12 percent, starting in January. And, the Fed announced it has no plans to raise interest rates any time soon.

The strong suggestion that interest rates will stay low means the Fed is not worried about inflation right now. But should it also worry about the opposite? Persistently falling prices, or deflation, can also wreck an economy, as the experience in Japan over the last 20 years has shown.  

Chris Farrell, Marketplace's economics guy, says that just because inflation is not a problem doesn't mean we don't have a potential economic problem on our hands.

"Inflation is an increase in the overall price level. Deflation is a decrease," Farrell explains. "So, on one hand, you say, 'Hey, things are getting cheaper. What is the problem?' The problem with deflation is that it can set off a downward debt spiral -- think Great Depression."

Click on the audio player above to hear more about why deflation can be problematic when investors have been so accustomed to a culture of borrowing.

About the author

Chris Farrell is the economics editor of Marketplace Money.

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