Prices Report Signals 5-Year Inflation Low

The U.S. economy received a boost Wednesday as inflation showed signs of falling to a five-year low in 1991, a trend economists said could prompt the Federal Reserve Board to lower interest rates again to accelerate the sluggish recovery.

Consumer prices rose just 0.2% in July for the second straight month, the Commerce Department reported, thanks to declining costs for gasoline and produce. Economists predicted that the inflation rate may finish the year just above 3%, the best figure since 1986.

The combined effects of recession, joblessness and declining oil prices following the Persian Gulf War have virtually wrung inflation out of the economy in recent months. The consumer price index rose at an annual rate of just 2.7% in the first seven months of 1991, far below last year’s rate of 6.1%.

But the bad news for consumers is that inflation is down in part because wages are falling, too. The Labor Department said that the average worker’s paycheck declined 1.4% in July, after adjusting for inflation. Over the last year, wages have fallen 2.3% when inflation is taken into account, the government said.

Despite that drop in living standards, economists are heartened by the consistently low inflation figures reported over the last few months. And they are now beginning to predict that the United States finally may be on the verge of its first prolonged period of extremely low inflation since the 1960s.

“We should be looking at inflation, which is virtually dead,” said Allan Meltzer, an economist at Carnegie Mellon University in Pittsburgh, Pa.

A new nationwide survey of small businesses reinforced the growing belief among economists that inflation is virtually dormant. The quarterly survey, released Wednesday by the National Federation of Independent Business, found that just 19% of small businesses plan to raise prices, almost a record low for the poll. Seventeen percent reported that they plan to cut prices.

The modest inflation figures, coming on the heels of gloomy reports detailing the sluggish pace of the recovery this summer, may increase pressure on the Federal Reserve to cut interest rates again. A rate reduction could occur as early as next Tuesday, when the Fed’s key policy-making committee meets to set interest rate policy. Economists believe that the central bank may lower the benchmark discount rate by as much as half a percentage point.

“I think we are going to see a rate cut, probably next week,” said Stephen Axilrod, an economist at Nikko Securities in New York and a former top Federal Reserve staff member.

Concerned that the recovery has not gained enough steam, the Fed moved Aug. 6 to cut one key interest rate. The central bank reduced the federal funds rate, which banks charge one another for overnight loans, by one-quarter of a percentage point to 5.5%.

The action surprised economists and other Fed watchers, because it followed a series of relatively upbeat comments on the recovery by Fed Chairman Alan Greenspan and other senior Fed officials. Greenspan had left the impression during congressional testimony in July that he did not see any need for further interest rate cuts in the foreseeable future.

But Greenspan’s optimism apparently has been tempered by more recent data showing that economic growth has been ragged, at best, for much of the summer. The nation’s money supply, the key statistic followed by the Fed to determine whether interest rates should be raised or lowered, has plunged in the last month, indicating that economic activity is faltering and inflation is falling.

Some Fed officials had opposed an aggressive policy of interest rate cuts, fearful that easier money would reignite inflation. But, with inflation falling and money supply growth dropping to the bottom of the Fed’s own internal targets, resistance to lower rates within the central bank seems to be evaporating.

At the same time, political pressure for lower interest rates seems to be building. The Bush Administration appears increasingly concerned about the possibility of a “double-dip” recession on the eve of the 1992 presidential campaign. In a double-dip recession, the economy falls back into a slump after only a brief interlude of good times.

Senior Administration officials backed off their criticism of the Fed earlier this summer when it seemed that the recovery was on course, and President Bush agreed to reappoint Greenspan for a second four-year term as Fed chairman. But now, senior White House officials are beginning to resume their earlier public calls for lower rates, and their criticism may grow louder in the fall if the Fed refuses to take further action.

“I think people should feel confident that, with this kind of pressure, the Fed will not let a double-dip recession happen,” observed Barry Bosworth, an economist at the Brookings Institution in Washington.

Other economists now agree with the White House that the Fed is moving too slowly. “If I were at the Fed, I would have cut rates already,” complained David Wyss, a senior economist at DRI-McGraw Hill, an economic forecasting firm in Lexington, Mass.

In fact, another piece of economic data released Wednesday suggested that the recovery is not gaining momentum. Business inventories fell 0.3% in June for the fifth straight month, the Commerce Department reported, a sign that businesses are not expanding production because consumer demand is not rising quickly. Meltzer warned that the inventory figures show the economy is “just bouncing along on the bottom.”