Why Inflation Isn't Sprouting In Mr. Greenspan's Neighborhoodby
Economic growth keeps rolling along despite the Federal Reserve's efforts to restrain it. Labor markets are at their tightest in five years. And consumer confidence is jumping. Right about now, signs of rising prices should be popping up like dandelions on a spring lawn.
Instead, the inflationary landscape remains a well-tended vista. Hardly a weed is in sight, and price pressures should stay tame for the rest of the year. What supports this sanguine outlook? Certainly, the Fed's seven hikes in short-term interest rates play a big part. Call them monetary preemergent--a strike against inflation before it could take root.
More important, labor costs are growing at the slowest pace on record, while rising orders for durable goods show that businesses are still investing in more productive machinery. This commitment to productivity combined with small gains in compensation will hold down the growth in unit labor costs--the major determinant of inflation.
Fed Chairman Alan Greenspan has emphasized the need to remain vigilant against even the slightest hint of price pressures this year. To that end, one of the central bank's greatest concerns will be any pickup in consumer demand. Consumers are clearly feeling more optimistic (chart). But reports on April retail sales don't show an overwhelming urge to splurge.
This shopping ennui is important to Fed policy. As long as demand grows only modestly, price pressures cannot build up any momentum.
TRUE, INFLATION FEARS remain. One reason is higher commodity prices. Prices for raw materials increased rapidly in 1994. But since January, they have flattened out. Higher input costs have not been passed through into the prices of finished goods.
One area worth watching is oil--still an inflation sore spot in the U.S. Crude-oil prices neared $21 per barrel in mid-April on news of a pipeline closing in the North Sea and low gasoline inventories in the U.S. But the repairs to the pipeline were completed sooner than expected, and American refineries have boosted production. So oil prices are back to near $20, pulling gasoline and heating-oil prices down with them.
Higher materials costs alone will not boost the inflation rate by very much, though. Nor will the weaker dollar. The most impmrtant element in the inflation outlook is the cost of labor. That's because compensation is a far greater expense for businesses than is the cost of raw materials. And unless an economy is growing fast enough to bid up wages, price hikes for input materials generally do not stick.
THAT SAID, the recent data on employment costs underscore the view that any rise in inflation this year will be modest. The cost of wages and benefits for all private-sector workers rose 0.6% in the first quarter. For the year ended last quarter, compensation was up 2.9%, the lowest growth rate in 16 years of data.
Benefits have led the slowdown. These costs edged up just 0.1% for the quarter and have risen only 2.9% for the year. Wages actually grew a bit faster, rising 0.8% in the first quarter. The Labor Dept. said that slower growth in health-care costs, state unemployment insurance, workmen's compensation, and employer contributions to retirement funds have contributed to the moderate increase in benefits.
Labor bills in the Midwest region are growing at the slowest rate in the nation. Wages and benefits there rose 2.4% over the past year--the lowest pace ever for the Midwest. The region's paltry increase pulled down the growth in labor costs for the entire U.S. (chart). The growth rates for the three other regions are still at least a bit above their lows, hit back in 1986.
The Midwest phenomenon says more about the erosion of unions than about the tightness of labor markets. In fact, jobless rates in the Midwest states averaged less than 5% last quarter--well below the national rate. But while unions still have a big presence in the manufacturing belt, their clout is rusting.
That's evident in the first-quarter report on collective bargaining settlements. The Labor Dept. said that union contracts settled in the first quarter call for annual pay raises of only 1.9% over the life of the contracts. These agreements replace settlements that won more generous pay raises of 3%.
Puny pay gains among union members make it hard to see how any upward push on wages will gel among workers generally. That's especially true if the economy slows. The Fed is betting that the economy will grow below its potential, creating slack in the labor markets. That will chill any wage pressures.
CRUCIAL TO THE FED'S BET will be consumers. In April, they felt pretty chipper. The Conference Board's index of consumer confidence jumped to 105.5 from 100.2 in March. It was the highest reading in five years. Households are upbeat about the current state of the economy. The present situation index rose from 115.3 to 117 in April, also a five-year high.
Consumers are particularly optimistic about job prospects. The Board said that 23.4% of respondents think jobs are plentiful. That's better than the 21.1% at the end of 1994, and it's just below the 23.7% who feel jobs are hard to get. What's more, changes in the present situation index are a good indicator of changes in employment. So nonfarm payrolls should show another gain when the April data are released on May 5.
Consumers remain uncertain about the future, though. The expectations index jumped in April, to 97.7 from 90.1 in March, but the index is no higher than it was a year ago or at the start of the expansion.
Higher spirits are not lifting store receipts. Retail sales for the first three weeks of April were weaker than in March, according to two trackers of weekly sales data, the Mitsubishi Bank-Wertheim Schroder index and the Johnson Redbook Report. Households have less extra cash because higher short-term rates are lifting the cost of existing adjustable-rate debt such as credit-card balances and mortgages.
Despite slack retail demand, the factory sector remains vibrant (chart). New orders for durable goods rose 0.6% in March, after a 0.7% drop in February.
The biggest gains were in electrical equipment and industrial machinery. These are the same goods destined for commercial use and exports. Orders for consumer durables have been falling recently.
What this means is that companies remain committed to expanding capacity and improving efficiency, even as the cyclical gains in productivity fall away. Smaller increases in factory output have eased capacity constraints in industry. High operating rates are usually a sign of production bottlenecks and shortages of supplies that lead to price hikes.
So far, though, the economy has eluded the weedy creep of rising prices. The slow pace of wages has clearly helped to plow under inflation. And for the rest of 1995, Greenspan and his cohorts stand ready with their spades and pesticides, intent on keeping inflation out of the well-manicured economic outlook.