Inflation: Monster Or Myth?

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This column was written by Irwin M. Stelzer.
So it has finally happened, just as the nay-sayers said it would. A memo is leaked suggesting that Korea's central bank is considering switching out of dollars, and the value of the U.S. currency drops. Unexpectedly weak job market and retail figures hit the wires, and the experts scramble to be first in print with downward revisions of their growth-rate forecasts. Economists at a leading investment bank muse out loud about $100 oil, consumer prices tick up one month, and the inflation hawks circle the Fed. A few companies open the earnings-reporting season with bad numbers, and investors scramble for safety.

The good news is that the bad news isn't all that bad, as investors seem to be realizing. The Korean central bank denied that it plans a massive unloading of dollars, and monthly jobs and retail sales figures are notoriously volatile. Oil prices have headed down, not up, since the much-reported $100 forecast, and the Saudis are promising to step up investment and production. As we have gotten deeper into the earnings-report season, the corporate profits picture turns out to be rosy, if unspectacular.

Which brings us to inflation. Last month core consumer prices (excluding food and energy) rose by 0.4 percent, twice the rate economists had been predicting, bringing the annualized 3-month increase to 3.3 percent, which, if maintained, is above the rate that would allow Fed chairman Alan Greenspan to relax when indulging himself in his habit of writing his speeches while having a good soak in the bath. More important, the index that the Federal Reserve Board's monetary policy committee watches has been rising steadily, at about twice the rate of a year ago. In the most recent survey of its 12 business districts, published last week, the Fed notes, "Price pressures have intensified in a number of districts."

Add to that picture anecdotal evidence that some of the nation's largest companies are recovering pricing power, and oil inventories so low that prices are likely to rise further during the summer driving season, and you have reasons that inflation worries are more than just imagined things that go bump in the night, to borrow from an old Cornish (some say Scottish) prayer.

But ask the wrong question, and you get a not very useful answer. The wrong question is, have prices been rising more rapidly of late? Answer: Yes. The right question is, will the recent behavior of prices force the Fed to abandon its policy of steady, "measured" quarter-point increases in interest rates, and drive long-term interest rates up to growth-retarding levels? Answer: probably not. Here's why:

The most obvious reason is that one-month, or even a few months, do not make a trend, especially when anyone with some memory of the behavior of prices in recent years analyzes the figures. The recent one-year increase of 2.3 percent might seem dramatic to "traders who graduated in 2002," but "for anyone with even one grey hair, most of their lives have been spent thinking that a 2.3 percent inflation rate is something close to an unattainably low ideal," reports the Lindsey Group in its latest advisory.