Inflation is back and the alarm bells are going off. The U.S. economy is burning along at a 6% annual rate since last summer. Some companies are again daring to raise prices, unions are demanding much higher pay, and health-care costs are shooting through the roof. Even OPEC is getting into the act with a surprising oil price hike. Shades of the inflationary '70s? Not one bit.

There's a world of difference between secular and cyclical inflation. One is built into the very core of the economy while the other ebbs and flows on the business cycle. The '70s were very definitely a time of core secular inflation. Productivity growth rates were abnormally low, budget deficits were high, companies automatically passed on higher costs through higher prices, and the Federal Reserve accommodated OPEC's oil price hikes by boosting liquidity. Inflation was woven into the fabric of the economy, and inflationary expectations became part of people's lives and buying habits.

Today's inflation is in an entirely different economic context. The cyclical upswing in the demand for goods and services is beginning to push prices up, but the spread of information technology continues to cut costs massively. Old Economy industries, such as autos, are just beginning to create business-to-business and other Internet strategies that will save them billions. As a result, the long-term growth trend of productivity, at about 3%, is nearly three times the level of the '70s. Ten years into an investment-led expansion, the capital spending boom continues, keeping productivity growth high. And Europe and Japan are just beginning their restructuring.

Government policies are also different this time around. Instead of inflationary deficits, we see growing budget surpluses all around the world. Instead of central banks accommodating OPEC oil prices, we see 82 tightening moves in the past year. While the Federal Reserve may have erred in creating too much liquidity to deal with Y2K, the Long-Term Capital Management collapse, and the Asian financial crisis, it is now moving to mop it up quickly.

Expectations are different, too. People grumble loudly about higher prices today. They expect prices to go down as they did during most of the '90s, not up. An inflationary psychology hasn't taken hold, at least not yet.

Stopping that inflationary psychology in its tracks is the most critical task the Federal Reserve faces. The tricky part is doing so without curbing the investment boom enhancing productivity. Today's cyclical inflation is floating on a wild, temporary surge in consumer demand from a too-hot-to-handle economy. Bringing it down to a sustainable 3% to 4% growth rate would be enough to do the job. The idea is to cool the economy while keeping capital spending up. Inflation is not built into the structure of the New Economy. Indeed, it's just the opposite.

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