Enjoy These Stable Prices While They Last

Do you want to make your own forecast of inflation for next year?  If you own a share of stock, or have taken out a loan, or have done just about anything with your money, you’ve effectively done that already.  Depending on what happens to prices tomorrow, your decision to buy, save or borrow at today’s prices will either be justified or second-guessed.

In the U.S. economy over the last few years, it’s been a pretty safe forecast.  Prices overall have been amazingly stable for many years running now – so stable, in fact, that the fear of inflation has fallen off the list of concerns for many households and businesses.  Prices change, of course, but largely due to shortages and surpluses in individual markets.  The upward creep of prices across the board has become almost negligible.  The Consumer Price Index, which rose by only 1.6 percent last year, actually fell by 0.2 percent last month.

It could be much, much worse.  In Israel in the 1960’s, or in Germany in the 1930’s, triple-digit inflation made workers sprint to the markets to spend their paychecks as fast as they could.  If they waited until the next day, or even until the end of the day, prices would rise and their

 purchasing power would erode.

Those situations now show up in textbooks as examples of economic mismanagement.  Another example shows up in those books that is closer to home.  In the U.S. economy in the 1960’s, we began the decade with remarkable price stability, fueled in part by healthy increases in productivity.  Economic growth picked up markedly after a tax cut by the Kennedy administration, expansionary monetary policy by the Federal Reserve, and a continuous ramping up of federal defense expenditures made in prosecuting the Vietnam war.

Does this scenario sound familiar?  The excesses of the 1960’s brought on an era of higher inflation, stagnant productivity, and economic malaise that it took many painful years to wring out of the economy.  Is the U.S. economy heading that direction again today?

It would be a mistake to laugh off the question.  The economy is not inflation-proof, yet every economic forecaster who has looked at the trends and has made a prediction of higher inflation so far has been burned by the refusal of actual prices to cooperate.  As we

 enter the third year of an economic recovery, when theory tells us that inflation pressures should be building, we find few changes on the stickers for products sitting on store shelves.

It’s a situation that is a little reminiscent of the stock market a few years back.  People knew -- in their minds -- that after two consecutive years of 30 percent returns, the chances of a third such year in the market were miniscule.  But on the day the market fell, how many of them still had their portfolios stuffed with growth stocks?

There are several reasons why we should expect higher inflation in 2004.  The economy will, in all likelihood, be running hotter.  Higher economic activity increases the chances for bottlenecks in transportation, shortages in labor markets, and price increases in commodities like wood, paper, and oil.  We’ve also experienced a significant fall in the U.S. dollar.  That puts upward pressure on prices of imported goods, and increases the pressure on the Federal Reserve to raise interest rates.

We’ve been wrong before, but someone still has to say it.  The days of negligible inflation are numbered.

Patrick M. Barkey