February 8, 2002
Recipe for Low Price Inflation
What do you get when you mix a strong dollar, a recession, and an unexpected surplus of crude oil production? In the national economy, the result is all around us: very low rates of price inflation. Not every sector of the economy is participating equally in the price freeze, and there is some question as to how long it will last. But a casual glance at the data reveals the remarkable fact that the growth in prices in general across the economy has practically stopped.
In the fourth quarter of 2001, the Consumer Price Index actually fell at a 0.4 percent annual rate in the national economy. In the forty years prior to the close of last year, negative growth in CPI over a quarter has only happened twice. And that remarkable performance comes on the heels of a July-September period that saw prices only edge up at a miniscule 0.7 percent annual rate. For companies that operate on a July fiscal year, that means that even a resumption of the "normal" upward creep in prices will likely produce a 1.5 percent rate of inflation for the year.
Not all prices in the economy are moving in the same direction, of course. The dominant force behind the sudden drop in overall prices has been the downward spiral of energy prices, led by oil. Motor fuel prices fell by 6 percent in December alone, and now stand almost 25 percent lower than they were a year ago. Those declines show up directly as reductions in housing and transportation costs, and indirectly in cost savings for a wide range of manufactured products.
On the other hand, the health care sector is marching to a different beat. Medical care prices increases have continued in the 4 to 5 percent range throughout last year. This rate, of course, understates the increase in health care spending, which is also driven by rapidly rising demand.
But outside of health care, the stars and planets seem to be aligned perfectly to reign in price inflation. The recession has simultaneously depressed demand and injected some slack into labor markets that had only recently been stretched very tight. The strong dollar has given imports pricing power leverage that has been a huge headache for domestic manufacturers, but a bonanza for bargain-conscious consumers. And a surprisingly strong productivity report on the U.S. economy suggests that businesses are still finding ways to cope with a competitive environment that effectively strips them of their pricing power.
The news that output-per-hour of the American workforce rose at a 3.5 percent rate in the final quarter of 2001 is surprising on at least two counts. In a recession, productivity typically dips as companies seek to keep their skilled workforce intact even as sales dip, in anticipation of a business pickup. Moreover, the severe drop inbusiness spending on plant and equipment suggests that modernizing plans are being put on hold. The increased productivity gives businesses breathing room to remain financially viable even as revenues are hit by the recession and foreign competition.
There's still plenty to worry about on the inflation front in the near future, however. The instability of oil supplies, the rapid rise in government spending, and the return of budget deficits are only a few items to make policymaker's brows furrow. But, for now at least, low price inflation has arrived, and it may be staying with us for a while.
About the Author
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