Claims that the economy is on the verge of outright deflation are misplaced. Not only will there be no deflation this year, but inflation will accelerate by year's end. Much of the deceleration in inflation during the past year is the result of a number of what will prove to be temporary events.
Energy prices, for example, have been pummeled by a myriad of factors, including the financial and economic woes in Asia, resumption of Iraqi exports, the recently announced increase in OPEC production quotas and the warm winter in the Northern Hemisphere.It is unlikely world energy markets will make it through the year without another disruption of Iraqi oil exports, however. Asian oil demand may even rise somewhat in coming months, since many Asian buyers probably have been holding off buying dollar-denominated oil as long as possible in the hope that their very depressed currencies make at least a partial comeback.
Falling import prices also have contributed to weaker inflation during the past year. The dollar's seemingly inexorable rise will come to an end in coming months as the Asian currency and financial crisis finally subsides. As investors deem Asian financial markets have hit bottom - and there is increasing speculation that this may soon be at hand - the dollar will lose some of its luster as a global safe haven.
Collapsing computer prices also have been a major constraint on inflation. Personal computer prices fell by 12 percent during the past year. But it is hard to expect similar declines this year. Margins in the industry have fallen enough to suggest that a significant shake out may soon occur. That eventually will limit the rate of future price declines.
A further deceleration in the cost of health care also was an important constraint on inflation last year. Health care cost inflation is expected to accelerate this year as the process of moving over to managed care is largely over.
Inflation will continue to get a lift from stronger growth in labor costs. Labor markets are acutely tight, and at the economy's current rate of growth they will grow tighter. Moreover, productivity will not increase enough to offset rising compensation costs, as employers will have to hire less than qualified labor in the tight labor market.
All this suggests that consumer price inflation will accelerate from just under 2 percent currently to near 3 percent a year from now. While this is still very modest inflation by nearly any standard of the past quarter-century, it is inflation nonetheless.