Inflation Returning to Normal as Wholesale Prices Jump 1.7% in October

The Producer Price Index is a good leading indication of future inflation because increases there are usually passed along to the consumer, thereby turning up months later in the Consumer Price Index. The PPI for October came out yesterday, and it was up 1.7%, the largest increase since 1990. Annualized, this rate is deeply into double digits, but because so much of it is exaggerated by the oil price rise (the fall will turn up in November’s figures) that some economists prefer to focus on “core” PPI, which excludes food and energy. Core PPI rose 0.3% or an annualized 3.6%, which is about where inflation is comfortable.

The Federal Reserve is a bit more conservative, viewing anything over 2% as risky. Then again, the Fed is not charged with making sure that every American who wants a full time job can get one. While the Phillips Curve that shows the trade-off between unemployment and inflation is not an iron law of economics, there is an inverse link between the two. And because the American welfare state is less generous than those in Europe, employment is a much more important vehicle for the delivery of social goods, e.g., health insurance.

Instead, the Fed concerns itself with price stability, which is something of a misnomer. What the Fed really targets is a fluid market in which prices rise and fall gently and almost predictably according to supply and demand for goods and services. If underemploying a million workers and putting an extra couple of tenths of a percent on the unemployment rate is the price for that price stability, Mr. Greenspan and his crowd will pay it.

With inflation back above 3% (even if it isn’t a sustained level), the Fed is almost certain to continue to tighten interest rates. Those less inflation-phobic can at least see levels from here at which higher interest rates will become necessary. And as oil prices drop and economic activity increases as a result, there is a risk of seeing 5% or more on an annual basis – too high for the economy to stay healthy in the long run.

Of course, all of this could go out the window if the core PPI for November turns out to have been negative. There is no reason to believe that it did, and in the run up to the holiday shopping season, there may be a burst of demand that keeps inflation in the news. The truth is it is hard to make a trend out of a single datum – although that is what most of the business press does. Inflation isn’t a problem right now, and it won’t be for the foreseeable future. The good news about the core PPI is that deflation isn’t a risk at all, inflation is moderate at worst, and if jobs pick up, the “just right” Goldilocks economy is a possibility again. At least, until the federal and trade deficits become overpowering some time in the future.


© Copyright 2004 by The Kensington Review, J. Myhre, Editor. No part of this publication may be reproduced without written consent.


Home