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Businessweek Archives

Leaks In The `Pipeline' Theory

Economic Trends


For inflation-wary Wall Street economists, the sudden rise in commodity prices in late 1994 and early 1995 was a sign of impending consumer-price inflation. The talk back then was that a rise in the price of raw materials would inexorably travel down the "inflation pipeline," forcing companies to raise prices for the goods they sold.

But a new study from economist Todd E. Clark at the Federal Reserve Bank of Kansas City casts some doubt on the pipeline theory. He found that the crude-materials producer-price index can often soar or plummet without affecting consumer prices. Costs of raw materials, for instance, rose sharply in 1987 without greatly pushing up consumer inflation.

The pipeline theory breaks down, Clark argues, because prices of consumer goods depend more on productivity and labor costs than on raw materials. In today's corporate environment--with productivity rising, wages flat or falling, and health-care costs moderating-- companies can earn good profits without raising prices. Indeed, intense competition may even force companies to lower their prices.

That may well be the reason why, despite the increase in raw-material prices that occurred earlier this year, the inflation rate for American consumer goods has been falling (chart). How low can it go? Edward E. Yardeni, chief economist at Deutsche Morgan Grenfell/C.J. Lawrence, thinks that the overall consumer-inflation rate could fall as far as 1.5% in 1996.BY MICHAEL J. MANDEL

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