For more than 20 years, inflation has shaped our financial lives. It governed the way we saved, invested, spent and borrowed money. It made long-range financial planning difficult,
Inflation also played a role in the sales of a long list of financial products, from money market funds to bond funds to limited partnerships. ("To keep ahead of inflation, put your money in . . . " was a common pitch.)
But what if there is no inflation, or virtually none, compared with recent history? What if, during the next 20 years, consumer price increases average 2 or 3 percent a year, instead of 4, 5 or 6 percent or more?
Those "what ifs" are here. In the Big Seven industrialized countries, the average inflation rate is back to the 3 percent level of the 1960s, with practically no sign of increase in the near -- or even medium -- future.
While this means more predictable future prices, it also means people need to develop reasonable expectations from their investments. To expect another decade of 15 percent-plus returns is not only unrealistic, it could be dangerous. In the 1990s a 6 or 7 percent return from bonds and 9 or 10 percent from stocks should be more than adequate.
This does not mean inflation is dead. A 3 percent inflation rate "is way higher than the rate of inflation in the 1950s," says Paul Boltz, chief economist at T. Rowe Price, the Baltimore mutual fund company. In 1958, for example, the Consumer Price Index rose 1.8 percent, he notes. In 1959 the rate was 1.7 percent; it was 1.4 percent in 1960 and just 0.7 percent in 1961.
But many of the underlying reasons that made inflation so much a part of our lives for the last two decades have shrunk dramatically or disappeared altogether.
Take borrowing, for example. "To really create an inflationary environment, people have to be willing to borrow to spend," says Charles I. Clough, chief investment strategist at Merrill Lynch & Co. Now, in tough economic times, "individuals and corporations aren't using credit to expand their purchasing power."
One result of this, Mr. Clough observes, can be seen in M3, one of the broadest measures of money supply. In the 1960s, fueled in part by the federal government's attempt to finance the Vietnam War and pay for new domestic programs, M3 grew 8 percent to 10 percent a year. In the 1970s it grew even faster, at 10 percent to 12 percent a year.
Now, however, the growth of M3 in the United States is zero, Mr. Clough says, while equivalent money gauges in Great Britain, France and Japan are shrinking. So there is no new money available for growth -- or to push up prices.