With core consumer prices still rising at less than a 1.5% annual rate, the Federal Reserve continues to view deflation as a bigger threat than inflation. Thus it is keeping money easy, apparently secure in the belief that it can quickly curb inflation when it reappears.
Economist Martin Barnes of investment advisers BCA Research in Montreal is not so sure. Given the uncertain lags surrounding monetary policy and the Fed's natural aversion to boosting rates in an election year, he worries that the markets and the Fed could be in for a "nasty inflationary surprise."
Barnes believes the economic risks have now shifted decisively in the direction of inflation. The return of payroll job growth, he argues, indicates that the expansion is finally on a sure footing and likely to post above-trend growth over the next year. And close analysis reveals that prices of most consumer goods and services actually have been trending higher for some time.
The main downward pressures on inflation, notes Barnes, have come from goods, particularly in industries facing competition from Asia. Further, falling prices are concentrated in durable goods, such as cars, furniture, major appliances, and computers, which account for only 11.4% of the consumer price index and by definition are purchased infrequently. Subtracting durables from the index reveals that high-frequency inflation -- that is, prices for goods and services that are bought more frequently -- is around 3% and has been edging higher recently. This jibes with consumer reports that the costs of many items, from taxi fares to health care and education, keep going up.
Barnes also points to signs that U.S. companies at the receiving end of Asian competition may soon get some relief. After falling in dollar terms for more than two years, the export prices of eight Asian economies, excluding China, are now rising modestly in dollar terms. U.S. non-oil import prices have been broadly flat for more than a year, and the prospect of further declines in the dollar in coming years suggests that import prices will start to trend higher.
At the same time, an improving manufacturing outlook in Japan and much of Europe indicates that global economic conditions are no longer deflationary. The proof of the pudding is in the recent sharp price increases of a broad range of industrial commodities.
The U.S. economy, of course, could deflect these inflationary pressures if productivity continues to surge higher. But like many others, Barnes believes that productivity growth is bound to slow as hiring accelerates. "The real question," he says, "is not whether inflation will rise, but whether it does so gradually or with surprising vigor." In recent decades, the vast majority of states began requiring applicants for teaching jobs in public schools to pass statewide certification exams. The idea was to raise teacher quality by ensuring that they met minimum standards for basic skills and subject knowledge.
Unfortunately, teacher testing doesn't seem to have achieved that goal, report Joshua Angrist and Jonathan Guryan in a recent National Bureau of Economic Research working paper. Using data from nationwide surveys of teachers and schools conducted from 1987 to 2000, they found that state-mandated exams did tend to raise teachers' salaries by some 3% to 5%. But they found no evidence that certification raised the quality of new teachers.
These findings are not surprising. Economists have long viewed licensing requirements with skepticism. While they tend to push up pay in the professions they protect, they also may discourage qualified applicants -- especially when other well-paying jobs without such requirements are readily available. Foreign aid is subject to the whims of donor countries. Multilateral lending institutions can tighten or turn off the spigot. And foreign investors can panic and bail out en masse. So what's a poor developing nation to do?
The answer for many is the money sent home by citizens working abroad. In the current issue of Foreign Policy, Devesh Kapur of Harvard University and John McHale of Queen's School of Business in Ontario write that migrant workers have emerged as "the most stable source of financial flows for poor nations."
In the past two decades, they report, remittances to developing countries have surged from $17.7 billion a year to nearly $80 billion. That's twice the foreign aid and 10 times the net foreign private capital they received in 2001.
This cash, say the authors, is helping to finance small-business startups and to lift entire nations out of poverty. And while fears that foreign workers may be stealing jobs and financing terrorism could temporarily slow the tide of immigration, remittances are almost certain to grow over the long-term. That's because the U.S., as well as many advanced nations whose populations are barely growing, depend on immigrants as a major source of workforce growth.