Is Inflation Data a Quirk? Even Experts Can’t Agree
Inflation fears picked up this winter, and it is worth examining whether those fears are justified. As it happens, I have examined the outlook for inflation in this column at about this time in each of the past two years. Conclusions from those earlier columns provide some perspective on how things look today.
In May, 1988: “We are still in the middle ground where inflationary pressures exist but are not alarming. Objective analysis indicates that the economy should be allowed to continue expanding at a rate that will gradually reduce unemployment further.”
For the record:
12:00 a.m. May 13, 1990 For the Record
Los Angeles Times Sunday May 13, 1990 Home Edition Business Part D Page 2 Column 1 Financial Desk Type of material: Correction
Economists charts--Two tables accompanying the Times Board of Economists column last Sunday had incorrect column headers. The tables should have appeared as below:
UNDERLYING INFLATION RATE
1Q90 Year end Year end Annual 1988 1989 rate Underlying CPI 4.6 4.2 6.9 Underlying deflator 4.5 4.1 5.6 Underlying PPI 4.0 4.3 3.3
*
ACTUAL INFLATION RATE
1Q90 Year end Year end Annual 1988 1989 rate Consumer price index 4.4 4.6 8.1 Consumption deflator 4.3 4.4 7.8 Producer price index 3.4 4.9 9.1
The unemployment rate then was 5.7%. Today, it is 5.4%, having gotten to 5.2% in the interim. Consistent with the analysis of 1988, markets are not overly tight today.
In April, 1989: “The genuine dilemma for the Federal Reserve will come if inflation does not come down even after the economic expansion has slowed and an actual economic recession becomes a clear risk. That may be the situation before the year is over.”
The economy did slow by last year’s fourth quarter, and inflation did not come down. Then, in this year’s first quarter, most price indexes rose much faster.
Should the spurt in prices since the first of the year change our view of ongoing inflation prospects? Is it scary enough to cause the Fed to tighten?
First some facts. The Actual Inflation Rate table shows this winter’s price spurt using three widely followed measures of inflation.
Each of the three indicators--theconsumer price index, the personal consumption deflator and the producer price index--rose much faster during the first quarter of the year than in the preceding four quarters or in the year before that. If these rates continue, we would be looking at a major ratcheting up of the ongoing inflation rate.
But part of the step up in first-quarter price increases can be accounted for by transient developments that do not portend a speed up in inflation. Food prices jumped sharply because the severely cold December weather killed fruit and vegetable crops in the East. And fuel prices rose but have already started back down.
The Underlying Inflation Rate table shows three measures of underlying inflation rates, which remove potentially transient price changes and are thus better indicators of where inflation is heading.
In each case, the actual price indexes are adjusted by removing the prices of food and energy. The underlying CPI removes prices for shelter and used cars as well.
The striking thing about these measures of underlying inflation is not that the adjustments reduce the first-quarter inflation rate, but that the consumer price measures remain high even after the adjustments. The 6.9% annual rate of increase in the underlying CPI is the fastest quarterly increase since the early 1980s. The 5.6% inflation rate in the consumption deflator is less unusual though still high.
The good news in the second table is in the producer price index, where removing food and energy prices cuts the first-quarter rate of inflation from the 9.1% annual rate in the overall PPI to only 3.3% in the underlying PPI.
The discrepancy between increases in underlying producer and consumer prices comes in part from the different coverage of the two series. The PPI omits services, including fast-rising medical care and distribution markups implicit in the retail prices sampled for the CPI.
Despite such differences, any sustained speedup of inflation would show up in both measures. So the good news about the first quarter is that the underlying PPI does not yet confirm the CPI speedup.
Hourly labor costs are another indicator of the underlying inflation rate in the economy. The best available measure of hourly wages and salaries for the private sector rose 4.2% in the 12 months ended in March, which is about the same increase experienced in the previous five or six quarters.
Hourly compensation, which includes the cost of benefits, rose by 5.2% in the year ended in March, which is about one-half point faster than compensation increases during the several previous quarters. Fast-rising costs of medical care benefits account for most of the difference between the increase in compensation and in wages and salaries.
Because compensation costs enter pricing decisions, the rise in compensation growth helps account for some of the first quarter’s increase in price inflation. But the fact that wage and salary increases continue to be so moderate suggests that no wage-price spiral has started.
With the evidence so mixed, it is still unclear whether this winter’s developments signal a faster pace of ongoing inflation or whether they are a temporary blip on the inflation horizon that will be gone by next quarter.
That the Fed has not tightened monetary policy suggests either that the board is confident that they are a temporary blip or that its members have other worries.
The fragile balance sheets of many financial institutions and the uncertain strength of the economic expansion are two reasons board members might not want to raise short-term interest rates at this time.
Underlying Inflation Rate
Year end 10’90 ’88 ’89 Underlying 4.6 4.2 6.9 CPI Underlying 4.5 4.1 5.6 deflator Underlying 4.0 4.3 3.3 PPI
Actual Inflation Rate
Year end 10’90 ’88 ’89 Consumer 4.4 4.6 8.1 price index Consumption 4.3 4.4 7.8 deflator Producer 3.4 4.9 9.1 price index
