WASHINGTON — For three years, Federal Reserve Chairman Alan Greenspan has been warning, with ever-increasing urgency, that there are limits to how fast the New American Economy can grow without sparking inflation. "We do not know where that point is," he would say ominously. But "when we reach that point, short of a repeal of the law of supply and demand," inflation will return.
Friday's consumer-price report provided the most tangible reminder in a long time that the law of supply and demand hasn't been repealed. Retail prices, excluding the volatile food and energy sectors, rose 0.4 percent in March from the previous month — and were up 2.4 percent from the previous year. That's not much if measured against the price panics of the 1970s, or even the moderate inflation of the 1980s. But it's the biggest monthly increase in the core inflation rate in five years.
And even a small speed bump can have a big effect on a speeding car.
Monthly economic statistics, of course, are only a misty glimpse of reality. This one, like so many before it, could turn out to be a fluke.
But it comes at a time when many of the anti-inflationary forces of the 1990s are waning. Costs for raw materials, imports and health care are no longer falling. Overseas economies, long able to service the demands of the American economy because they were weak, are picking up steam. Labor markets are growing ever tighter, and showing new hints of pushing up labor costs. The great American shopping binge shows no sign of slowing.
So more than at any time in recent years, a bad inflation number has to be taken seriously. "We're in a period of heightened alert," says Edward Boehne, president of the Federal Reserve Bank of Philadelphia. "We've moved beyond just the risk of accelerating inflation to some preliminary, fragmentary suggestions that we might be seeing some accelerating inflation."
The belief that inflation may have been permanently licked is one of the underlying myths of the millennial economic boom, and its accompanying bull market. And indeed, much of the conventional wisdom about what causes inflation has long been shattered. Just half a decade ago, mainstream economists agreed that an unemployment rate of 6 percent or lower would cause prices to accelerate. But unemployment slipped below 6 percent in 1995 and below 5 percent in 1997, while inflation continued to slow.
Low inflation — and the widespread conviction that it would stay low — has had myriad benefits. It has spurred an investment boom by giving executives the confidence to plan far into the future without uncertainty over prices. It has been used to justify the sharp rise in the valuation of stocks, with experts arguing that long-term stability in prices — and hence interest rates — lowered the long-term risk of equities.
The prospect of inflation's resurgence is especially chilling because all but one recession experienced since World War II was the direct result of rising prices and the Fed's jacking up interest rates in response.
The March price number, and the brutal stock-market sell-off that accompanied it, have now put Greenspan, the country's top inflation cop, in an uncomfortable bind. His primary mission is to keep inflation — and fears of inflation — under control. To the extent that Friday's news suggests the Fed is falling behind the curve, it would seem to make an interest-rate increase imperative when policymakers next meet May 16.
The price report will even give fresh ammunition to those officials who advocate pushing up rates by a forceful half a percentage point next month — rather than simply matching the five quarter-point steps since last June — to snuff out any possible shift in inflation sentiment. The "gradualist approach" has been fine as long as the Fed has been "moving preemptively against the threat of higher inflation, without any direct corroboration from data on inflation," Fed Governor Laurence Meyer, one of the central bank's leading hawks, said in a speech delivered last Wednesday. But, he added, if inflation expectations pick up, "it would be important to react more aggressively."
On the other hand, if the market's precipitous decline continues, the Fed will be loath to make it worse. And while all evidence is that the economy continues to gallop at high speed, the instant evaporation of trillions of dollars in stock-market wealth may well presage some slowing in the excessive consumer spending that has so worried officials.
After Friday's plunge, the Wilshire 5000 — the index of all publicly traded United States-based stocks that the Fed prefers to the narrower Dow Jones Industrial Average and NASDAQ gauges — was up just 3 percent from a year earlier. Fed Chairman Greenspan suggested in comments earlier this year that the market could grow as fast as a 6 percent annual pace without contributing to inflation.
Should market turmoil continue over the coming weeks, "either the volatility in the market or the level of prices could stay the Fed's hand," says Daiwa Securities America chief economist Michael Moran. "The wrenching experience in 1998" — following Russia's debt default and the near collapse of a major hedge fund — "most likely will leave officials reluctant to stir a boiling pot," he added.
For all the hand-wringing over the March consumer price report, it's worth keeping the number in perspective. Though price increases were broad-based, it would be premature to declare a trend. The 0.4 percent monthly increase in the so-called core rate — excluding food and energy prices — followed two consecutive months of much tamer 0.2 percent increases. Just the day before releasing the consumer price index, the Bureau of Labor Statistics announced that core prices at the wholesale level — sometimes considered a precursor of future inflation patterns — rose a modest 0.1 percent, and had decelerated from February.
The March consumer-price figure reflected the spillover of higher oil costs into other sectors, notably transportation, which registered the biggest one-month jump of any sector outside energy. But with the Organization of Petroleum Exporting Countries agreeing to boost production in late March, energy prices are falling again, and those other prices are expected to ease as well.
"This number is a reminder that inflation risks are real in today's economy," Fed Vice Chairman Roger Ferguson observed after Friday's report. "However, one would hope that one month's number wouldn't precipitate a major re-evaluation of inflation expectations." The April price report — due to be released the morning of the next Fed meeting — will help determine whether the March figure was a fluke or a turning point.
In recent public comments, Greenspan himself has been upbeat about the prognosis for prices. Asked at a Senate hearing Thursday if he had seen any fresh evidence of inflation in recent weeks, he responded that "if you look. . . t the underlying cost structure of American business, I see no evidence of an acceleration in unit costs."
Via Associated Press