The Lukewarm Breath of Inflation
Is inflation heating up again? After four years of moderation, price statistics in 1987 have alarmed many observers. Most dramatically, prices of industrial raw materials such as steel, copper, lumber and oil have risen at a 33% annual rate in 1987. Even without taking energy prices into account, prices of industrial raw materials have risen at a 25% annual rate.
This flare-up has been blamed for causing the government bond market, highly sensitive to signs of inflation, to decline in recent weeks, and raw materials prices are being watched closely by the financial markets.
Although not as volatile as raw materials prices, finished goods prices are up noticeably. Last year, the consumer price index rose only 1.2%. But during the first half of this year, it rose at an annual rate of 5.3%. The producer price index, which measures prices of domestic goods at the wholesale level, actually declined by 2.3% last year and has risen at a 4.5% annual rate during the first six months of 1987.
Before concluding that the long battle against inflation has been lost, however, a couple of points should be considered.
First, the increase in non-energy raw materials prices this year, though impressive, has just brought these prices back to about what they averaged in 1984. In the short term, raw materials prices could go even higher. That is so because the productive capacities of industries, such as copper, declined during the years when prices were low. But today’s higher prices will make it profitable to increase capacity, which eventually should ease pressure on prices.
Moreover, the prices of industrial raw materials other than oil constitute only a small fraction of the cost that consumers and businesses pay for products.
What about the increases in the measures of finished goods prices, the consumer price and producer price indexes? To see the full picture, it is useful to compare what these indexes have done against some measures of the underlying rate of inflation. The underlying measures, none of which alone is definitive, ignore the effects of volatile food and fuel prices, which fluctuate for reasons often unrelated to the general economy. For similar reasons, the underlying rate for the consumer price index also discounts used car prices and shelter costs. Because wages are the most important determinant in most prices, they provide still another indicator of underlying inflation.
The statistics show that for the first half of this year, underlying inflation is lower than actual inflation as measured by both the consumer price and producer price indexes. Further, the underlying measures of consumer price and producer price inflation are lower than they were last year. Wages, though rising faster than in 1986, still are up only a very modest 2.4% on an annualized basis for 1987.
Thus, it is clear that much of the rise in inflation this year has come from increases in the prices of certain goods, mainly fuel, that are not related to the basic inflationary process. Fuel prices fell last year, bringing down the broader price indexes, and have risen this year, bringing the indexes up. All told, the underlying inflation rate, however, has changed little, if at all, thus far in 1987.
What can we say about the next 12 to 18 months?
If, as I expect, both the dollar and oil prices stabilize, the extra inflation that has come from rising prices for imports and fuel soon will run its course. Increases in the consumer price and producer price indexes will dovetail more closely with their more stable underlying inflation rates which, in turn, will be closely related to wages. Thus, if there is to be a serious increase in overall inflation in the future, it will come from a higher rate of wage inflation.
Wages could go up as a result of the recent increase in the consumer price index and the decline in the unemployment rate during the last year to 6.2% in June. But these forces are not likely to change things very much.
Just as the pattern of highly inflationary wage increases was hard to break in the early 1980s, the recent pattern of small wage increases will not easily give way to a new explosion. On balance, the underlying inflation rate should rise next year, but by less than a percentage point. And with the end of the temporary factors that have raised prices this year, overall inflation in 1988 should be no more, and possibly less, than it is this year.
That would be good news. But even a 4.5% rise in the consumer price index in 1988 would be far more than in 1986. So, to answer the question I raised earlier, inflation is not heating up, but it is warming.
MEASURES OF U. S. INFLATION
1986 1st half 1987* Consumer price index 1.2% 5.3% Producer price index -2.3% 4.5% Underlying CPI 4.2% 4.0% Underlying PPI 2.6% 1.8% Wages 2.0% 2.4%
*annualized
