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May 13, 2005

Expect More Tightening by the Fed

If the Federal Reserve’s steady diet of interest rate increases is giving you or your business indigestion, then I’ve got a suggestion for you.  Get used to it.  The inflation winds in the U.S. economy are whipping up like they haven’t in almost a decade.  And it’s up to our central bank to do something about it.

We learned a few years ago that rapid advances in technology and globalization didn’t make the national economy recession proof, as some foolishly boasted.  It looks like we may be soon learning the same painful lesson about inflation.  With commodities prices soaring, energy prices high, and health care costs still spiking, there is pressure on companies in all industries to push those costs forward to the final customer.

That, by itself, is nothing new.  Goods manufacturers in particular have been getting squeezed by higher costs for several years running.  The difference now is that many of the higher costs, especially for energy intensive industries, are being felt by competitors abroad as well.  And some of the price increases companies have been dangling for years in front of their customers, only to pull them back in the face of competition, are starting to stick.

The wave that is building hasn’t fully reached consumers.  Not according to the two most watched measures of inflation, the Consumer Price Index (CPI) and the Gross Domestic Product (GDP) price deflator.  Both are strongly up for much of 2005, but at levels that remain tame by historical standards.  The GDP grew at a 3.3 percent annual rate in the first three months of the year, while even after a strong spike in March the CPI stood only 3.1 percent higher than the same month last year.

But the story for businesses is another matter.  For more than three years, purchasing managers responding to the Institute for Supply Management’s highly watched monthly survey have reported paying higher vendor prices.  In April 71 percent of those asked reported higher prices for intermediate goods and materials.  The list of commodities whose prices are rising is as long as your arm – including aluminum, energy goods, paper and many plastics.  Only steel has offered some relief to the chorus of higher prices, and the easing comes after more than a year of sharp increases.

Medical care is another source of cost pressure.  Because individuals pay only a fraction of the cost of their own care, the acceleration in prices reflected in the CPI has not, by itself, been a significant factor in fueling inflation.  Still, the 6.0 percent annualized rate of increase in medical care prices over the last three months is not a comforting sign.

But prices and costs are not the same.  Increased rates of utilization, fueled in part by advances in pharmaceuticals, have been hitting businesses who provide health care benefits to their workers hard for some time now.  Even though those costs, as reflected in the benefit cost component of the Federal government’s employment cost index, have moderated slightly this year, they continue to climb sharply.

The one source of relief of cost pressure for businesses is hardly welcome news for most families – namely, a surprising weakness in wage growth.  Wages and salaries are running only about 2.5 percent higher than year-ago levels, despite the stronger hiring and falling unemployment rates experienced nationwide.  Employers may feel powerless in the face of rising benefits costs, but their grip on wage costs is quite a bit firmer.

And now we come to the energy sector.  About the only good thing you can say for the 21.1 annualized rate of increase in energy prices over the last three months is that it has kicked businesses and households into finding ways to conserve.  And that, together with the sizable declines in energy prices that have been interspersed among the increases, may explain why high prices have yet to either kill the economic recovery or spark serious inflation.

But on top of everything else, it’s a burden the economy can’t bear forever without showing the strain.  And we can expect the Fed to keep raising rates to ease the pressure.

Link to this commentary: https://commentaries.cberdata.org/269/expect-more-tightening-by-the-fed

Tags: business


About the Author

Pat Barkey none@example.com

Patrick Barkey is director of the University of Montana Bureau of Business and Economic Research. He served previously as Director of the Bureau of Business Research (now the Center for Business and Economic Research) at Ball State University, overseeing and participating in a wide variety of projects in labor market research and state and regional economic policy issues. Note: The views expressed here are solely those of the author, and do not represent those of funders, associations, any entity of Ball State University, or its governing body.

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