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Wednesday June 02, 03:39
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Fed Takes Close Look at Inflation
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When Federal Reserve officials updated their personal forecasts for the U.S. economy in January, most of them expected inflation to be slightly lower this year than in 2003. Well, forecasting inflation has always been a tricky business.
What’s puzzling officials is why inflation flared up so quickly this year. Part of the answer naturally is oil and the highly uncertain situation in Iraq. The inflationary impulse has been broader than oil though, and it’s not clear exactly why.
Some Fed critics have said all along that keeping the central bank’s target for overnight rates at 1 percent for so long was providing fuel for a surge in inflation. So they are feeling vindicated, and they are urging action to raise the target significantly as soon as possible.
While acknowledging that the inflation outlook has worsened relative to what they expected, a number of Fed officials have said publicly that there is, as yet, no firm evidence that prices are soaring out of control.
Labor Costs Moderate
In particular, labor costs are still rising very moderately, if at all. So as long as they don’t start to outstrip strong productivity gains, underlying inflation pressures should remain subdued.
Furthermore, on Friday the Commerce Department reported that the core personal consumption expenditure price index rose at an annual rate of only 1.7 percent in the first three months of the year and was up only 0.1 percent in April.
That was in sharp contrast to the large increases in the core consumer price index in both March and April.
Nevertheless, the less benign inflation news this year, coupled with strong job gains in March and April, have made it highly likely that Fed officials will raise that 1 percent target by 25 basis points at a June 29-30 policymaking session.
That won’t be enough to satisfy the critics, but Fed officials aren’t out to crunch the economy.
Harvey Rosenblum, research director at the Dallas Federal Reserve Bank, is among those whose inflation expectations have gone awry. In a recent Bloomberg interview, he said he had expected inflation to slow this year and ``so far, I’ve been proven wrong.’’
Bernanke’s Pretty Calm
Rosenblum and his boss, Dallas Fed President Robert D. McTeer Jr., are hardly panicked over the strong inflation reports.
``I’m not overly concerned now but it’s something that central bankers are paid to watch,’’ McTeer said in a recent speech.
Fed Governor Ben S. Bernanke is pretty calm as well.
``As we look ahead, core inflation appears likely to remain in the zone of price stability during the remainder of 2004 and into 2005,’’ Bernanke said in a speech.
He then ticked off a long list of reasons why he thought that was the case: slack in labor and product markets, rapid gains in productivity, high profit margins, intensified global competition, and what he called ``well contained’’ long-term inflation expectations.
That’s a powerful list, which also indicates why officials have been so surprised at this spring’s inflation blip.
Surging Economic Growth
Of course, oil prices have shot up, as have prices of many commodities, and the value of the trade-weighted dollar has come down. Still, none of those factors explains why companies suddenly feel they have the pricing power needed to pass those higher costs on to their customers.
The answer may be rooted in the relatively sudden complementary surges of economic growth in the U.S., China, Japan and other East Asian countries.
As orders for products at all stages of production began to pile up, suppliers have struggled to meet the increased demand. In some cases, bottlenecks have developed, including at notoriously inadequate ports in China that have caused long backlogs of ships waiting to unload or take on cargo.
All this seems to have triggered a psychological shift among executives making pricing decisions. If goods are hard to get when you want them, why not raise prices.
In the U.S., the Institute for Supply Management’s monthly index of vendor deliveries rose to 69.4 last month, the highest share in 25 years.
Pricing Power
Under such circumstances, companies may feel they face less risk of losing market share if they raise prices, or that they are not in a position to grab part of another company’s share if they keep their price low.
Some of this newfound pricing power may be temporary. To the extent that delivery bottlenecks are the problem, ways may be found to ease them. Or demand may cool off, as it already is in some cases.
For example, China has taken several steps to cool down its overheating economy. Soybean crushers reportedly have begun to default on purchase contracts because they can no longer get needed financing. As a result, the soybean futures contract for July delivery, which nearly doubled between July and March, has since lost about 45 percent of the earlier gain.
Scrap steel, wheat, copper and cotton prices also are all off their highs. On the other hand, prices of crude oil and other energy products remain close to their highs.
`Be Cool’
Economist Ken Mayland of ClearView Economics in Cleveland last week drew a sharp distinction between a generalized inflation and what he labeled ``one-time price increases.’’ The former, he said, ``requires a monetary policy response while there can be some forebearance of one-time changes in the price level.’’
Mayland put rising oil and food prices, as well as higher import prices stemming from the fall in the dollar, in the ``one- time’’ category.
He wasn’t arguing against a Fed move to raise the 1 percent target, rather that the Fed does not need to launch a series of aggressive moves such as some critics are demanding.
Meanwhile, economist Robert V. DiClemente of Citigroup, sent his clients a commentary on Friday with the title, ``Be Cool.’’
``The economy does not seem to be on an overheating trajectory that would unduly strain resources and require aggressive action by the Federal Open Market Committee,’’ DiClemente said.
The commentary noted that expectations of a Fed rate increase have already caused U.S. financial conditions to tighten. If the Fed raises the 1 percent target by more than 100 basis points during the next year that ``would slow the economy abruptly, pushing demand growth below trend in early 2005.’’
That’s a much smaller estimate of the rise in interest rates needed to keep inflation well under control than that offered by most economists -- or most Fed officials.
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