And you thought low prices were a good thing.

The U.S. government today reported that inflation dropped by 1 percent in October—the biggest drop in the 61 years inflation records have been kept. Last month, The Big Money ran this piece by Martha C. White, explaining what deflation might mean to the U.S. economy. 

The Federal Reserve today dropped the benchmark fed funds rate to 1 percent, a nearly unprecedented move. While the Fed has flirted with low rates before and even dropped the rate to 1 percent between June 2003 and June 2004, that was when the housing boom was in full swing and everyone was operating under the assumption there was nowhere to go but up.

These are different times. Now, the finance industry is in a state of disarray, and global markets are seesawing. It's a telling sign, though, that even as Treasury yields plummet in response to en masse investors seeking a safe haven, their inflation-adjusted counterparts, otherwise known as TIPS, have been on an upswing, sometimes even surpassing comparable conventional Treasury bills. Economists aren't really worried about inflation right now-because they're too busy worrying about deflation instead. Deflation is when across-the-board prices for goods drop and assets lose value. But wait-weren't we just wringing our hands over $4.50 gas and $4 milk? Don't we want low prices?

Well, yes and yes, but no. Low prices are good when they stem from an increase in production efficiency or market competition. When deflation is the reason, those prices aren't falling in a vacuum. Along with reverse sticker shock, you're getting paid less, your house is worth less than it was a few years ago, and your 401(k) tanks. The only thing that hasn't gone down is your debt, and there's the rub: Whatever you owed on credit cards, student loans, and your mortgage before deflation doesn't change, although now you have less money to pay it off. When it comes to mortgages, there's an added disincentive to keep paying if home values have fallen so far that a turnaround looks unlikely. Businesses and even governments wrestle with this same problem on a much greater scale. A tandem drop in salaries and revenues might theoretically even out (although that's certainly no guarantee). The bigger problem is that debt obligations are still fixed, leading to a budgetary nightmare.

Until now, deflation wasn't much of a consideration in the post-Depression era. Looser monetary policy gave the government the power to add dollars to the economy if a Depression-caliber contraction of the money supply happened again. Economists and the business media tended to focus on the more common concern of inflation. There was a blip of worry that the United States could be dipping into a period of deflation after the tech bubble burst in the early part of this decade, but that was left in the dust as the economy galloped ahead.

In these times, though, most economists believe that fear of inflation is overblown in light of everything else that could go wrong. Under normal circumstances, the American economy actually depends on a slight degree of inflation to keep running smoothly. Inflation is the bacteria of the financial world: It carries a certain ick factor and can cause a lot of trouble if allowed to grow unchecked, but a carefully calibrated amount is essential to keep the bigger, loftier parts of the system functioning properly.