The Numbers Don't Add Up To Inflation

It's certainly possible to panic, as the bond markets have done. Never mind that unemployment is stuck at 7%. Never mind that industrial capacity is at a modest 81.4% or that the U.S. economy is in the most sluggish of recoveries. A couple of months of bad inflation news, and the bond markets have decided the inflation dragon is back and breathing fire. Worse, some folks at the Fed are getting a case of nerves over the price numbers, leading to a tussle over the direction of Fed policy--to tighten or not to tighten.

It would be a mistake for the Fed to tighten right now. True, consumer prices and producer prices have popped up. So far this year, the CPI has risen at a 4.3% annual rate, up from 2.9% last year. Producer prices, meanwhile, have risen 4.8%. Commodity prices have also bobbed and weaved a bit this year, and there are, to be sure, some concerns that new taxes will push the indexes higher.

But these developments do not an inflationary outlook make. Two factors crucial to any sustained surge in prices are missing. First, wage and compensation gains remain stunningly moderate. Compensation costs, including wages, salaries, and employer costs for employee benefits, rose 3.5% in the year ended March, 1993--the same rate of increase for the year ended December, 1992. And with productivity, especially in manufacturing, showing healthy gains, unit labor costs are well under control. If inflation were a problem, the push from wages would be apparent. It's not.

Second, the classic ingredient that sustains inflation, rapid money growth, is missing. The narrowly defined M-1 grew at a 4.4% annual rate during the last quarter. Meanwhile, the broader aggregates, M-2 and M-3, which most economists look to now as better monetary indicators, actually shrank by 2.2% and 2.6%, respectively, during the same period. Over the past year, M-2 has grown a mere 0.2%.

Not only do the data on compensation and monetary aggregates tell us that inflation is not a problem; they also tell us that the recovery is still fragile. And that, more than anything else, is reason enough for the Fed to stand firm in the face of a few bad inflation numbers.

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