JUST four months ago, soaring commodity costs were the biggest economic worry as the oil price raced to a record high.

Now the buzzword is deflation, which is altering both the economic outlook and the way governments need to respond to the threat of a deep recession.

In a recent note to clients, Merrill Lynch economist David Rosenberg said: 'The combination of falling commodity prices, rising unemployment and our expectation for several quarters of negative real growth suggests that (Federal Reserve chairman Ben) Bernanke will, perhaps within the next year, come face-to-face with his greatest fear: Deflation.'

Falling prices are damaging to the economy because they encourage consumers to delay purchases and companies to cut costs - exactly the opposite of what is needed to revive growth and get credit markets functioning normally again.

For now, the risk of prolonged deflation looks remote, in large part because the United States, Europe and others are injecting trillions of dollars to reflate their economies, with more money likely to come soon.

Chief economist Olivier Blanchard at the International Monetary Fund (IMF) said headline inflationmeasures would probably briefly dip into negative territory in the 'near future'.

Economic data due this week is expected to show that German wholesale prices dropped 1 per cent month-over-month last month, while euro-zone inflation rose a modest 0.1 per cent, according to Reuters polls.

The European Central Bank, Bank of England and Swiss National Bank all cut short-term interest rates last week, and more reductions are expected before the year is through.

But lower rates do not do much for the broader economy when banks are reluctant to lend and consumers and firms have little interest in borrowing.

When the private sector cuts back, it falls to government to fill the void. The IMF said last week that more fiscal measures were needed as the developed world faces its first year-long contraction since World War II.

Mr Rosenberg and other economists have been re-reading a speech Mr Bernanke gave in 2002 on how to tackle deflation.

His suggestions included expanding the Fed's purchase of assets and offering low-interest loans to banks - two things the central bank has already done.

So how much more is needed?

Much of the focus so far has been on getting money into banks in the hope that they will turn around and lend it.

Attention is now starting to shift towards putting money in consumers' pockets and into infrastructure projects that would generate jobs.