The Higher Price of Economic Growth

The surprising strength of October's core inflation is a bigger worry than the producer-price jump, says S&P chief economist David Wyss

By Steve Rosenbush

Last month, wholesale prices posted their biggest increase in 14 years, the Labor Dept. reported on Nov. 16. The Producer Price Index, a gauge of prices received by farms, factories, and refineries, rose 1.7%, nearly twice as high as forecasted. The core rate of inflation, which excludes volatile food and energy prices, rose a greater-than-expected 0.3%.

While the latest numbers show legitimate cause for concern, it's not time to panic, says Standard & Poor's chief economist David Wyss. The 1.7% increase in total PPI mostly reflects soaring energy prices, which have already started to come back down. It also includes a hurricane-related spike in food prices (see BW Online, 11/16/04, "Energy Fuels an Inflation Surprise").


  Wyss views the stronger PPI as a "one-time blip." He says he's more concerned about the 0.3% gain in the core rate of inflation, since most economists had expected an 0.2% rise.

The surprise gain was the result of a jump in the price of imported goods, such as apparel. The weak dollar is pressuring the profit margins of companies that export to the U.S. Until now, these businesses have been eating the losses. But as the economy improves, they're starting to pass the higher costs along to customers at the wholesale level.

Nevertheless, more costly imported goods won't create an economis crisis. The benefits of the weak dollar may outweigh the damage because it will make it easier for U.S. exporters to sell their goods abroad. And that will boost jobs in the U.S. manufacturing sector.


  The reality is that inflation's core rate will move modestly higher. On an annual basis, Wyss expects the pace of inflation to rise 2% to 2.5% a year, vs. the recent 1.5% to 2% range. That means the Fed is likely to continue to boost interest rates. Wyss expects the Fed to raise short-term rates to 4% by the end of 2005.

For now, it appears that the U.S. is experiencing growing pains as the economy strengthens. Indeed, the days of deflation and free money are over. But the latest data signal that the period of anemic growth in the labor market is ending. By far, that's a better-than-fair trade.

Rosenbush is a senior writer for BusinessWeek in New York

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