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Producer Prices Rise 1.8 Percent; Should the Fed Be Worried About Inflation?

The Bureau of Labor Statistics announced today that wholesale prices rose 1.8 percent in November. That is likely to bring the inflation hawks out in full force -- expect to hear calls for the Fed to begin raising rates sooner rather than later -- but it's too soon to start thinking about rate increases.

First, as the report indicates:

About three-fourths of the November advance in the finished goods index can be traced to higher prices for energy goods, which jumped 6.9 percent.
So this is primarily a result of rising energy prices. Energy prices tend to rise and fall over time taking input prices with them, but the month to month variation does not translate into longer run inflation problems.

Second, month to month changes in the index are very volatile:

Nov 2008 -2.7
Dec 2008 -1.8
Jan 2009 0.9
Feb 2009 -0.1
Mar 2009 -0.9
Apr 2009 0.4
May 2009 0.2
Jun 2009 1.7
Jul 2009 -1.2
Aug 2009 1.9
Sep 2009 -0.6
Oct 2009 0.3
Nov 2009 1.8

The 1.7 percent increase in June was followed by a 1.2 percent decline in July, and the 1.9 percent increase in August was followed by a .6 percent decline in September. So a one month blip in the data does not indicate a new trend; monthly data are far too noisy to draw strong conclusions from a one month change.

Third, a weaker dollar contributed to the increase, but that will help exports and is a necessary adjustment. The Fed will not be inclined to offset it. More importantly, aggregate demand remains weak, and though capacity utilization ticked upward according to data released today, there is still considerable excess capacity in the system (though this indicates it may not be quite as large as official estimates suggest). Weak demand and the presence of excess capacity should temper any pass through of price increases for raw materials to the price of goods and services.

Fourth, long-term bond yields show no hint of worry about future inflation.

Finally, employment has not yet turned the corner -- it is still declining albeit at a slower rate -- and the recovery of output is only just beginning. A rate increase now, or a signal that one is coming soon, could endanger the recovery of output and risk repeating the experience of 1937-38. At that time, the economy was beginning to recover from the Great Depression, but over anxious policymakers cut government spending and raised taxes due to worries about the budget deficit, and increased interest rates due to worries about inflation. These moves drove the economy right back into the doldrums. We should avoid repeating that mistake.

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