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The Inflation Update: September 2001 Stephen G. Cecchetti 19 October 2001 Oxford, England As the economy continues to slow, the question is will inflation follow. So far, the answer is no. There continues to be a strong belief in a link between general economic slack and movements in overall inflation. The fact that we experienced all combinations of high or low inflation and above or below trend growth does not seem to shake the conviction of those who believe. But religion is not science, and inflation is not well forecast by things like output gaps (even if you could measure them with any precision). Inflation is a process with substantial inertia, and so the best predictions about the levels of the next few years come from looking at the details of the current inflation reports. This all brings us to the stagflation of 2001 and the fact that economic growth is now almost surely negative while trend inflation has risen to three percent. Choppy energy price movements continue to be reflected in the monthly changes in the overall CPI, which rose 4.8% (at an annual rate) from August to September. Core measures continue to do their job of eliminating short-term volatility. The conventional core CPI, the index that excludes Food and Energy prices, rose 2.6% (a.r.) last month while the Median CPI of the Federal Reserve Bank of Cleveland registered an increase of 2.9% (a.r.). Over the past twelve months, the headline and ex. Food and Energy measures have both risen by 2.6%. Meanwhile the median CPI rose 3.7% A few notes on the detail of this month’s report. First, overall shelter prices were held down by a transient decline in lodging away from home. Hotel room prices dropped an average of more than three percent for the month, or 30% at an annual rate! The dramatic drop in car and truck rental prices is another sign of the difficulties the tourism industry faced last month. Second, commodities excluding food and energy commodities – what I think of as core goods prices – rose at a 4.2% (a.r) last month. Meanwhile core service prices, those excluding energy services, were up a very modest 1.1% (a.r.) For years we have thought of goods price declines as being the break on service price increases. What now? Looking forward we face two big questions on the inflation front. Will housing price inflation abate anytime soon? And, is the productivity growth trend at the 1989 level of 2%+, 1999 level of 3%+, or somewhere in between? These come as no surprise to the readers of my updates. Housing prices, especially owner equivalent rent (OER), are central to my assessment of inflation trends. Changes in aggregate productivity growth are at the core of everyone’s concerns, and seem to explain some of the otherwise anomalous events of the past five years. In looking at today’s report, we see that OER inflation has averaged nearly 4% for the past year. Reductions in the federal fund rate, and the concomitant fall in mortgage costs, continue to have the intended effect of propping up the housing market. The end may be in sight now, as the most recent data show a more modest 2.9% rise in OER. Things do not look to be out of hand, but in the end inflation is still at roughly a 3% level. Long-term productivity growth is another matter entirely. Here I do not share the optimistic views of Chairman Greenspan for two reasons. The first is the generally agreed upon view that the purchase of security equipment and changes in behavior will cost both physical resources and time, reducing measured output per hour worked. But beyond that, I am becoming increasingly suspicious that the productivity acceleration of the late 1990s can be tied to the production of information technology and communication equipment that was purchased by business with very little internal payoff. We should all be haunted by the images of warehouses piled high with barely used computers. And while the engineers continue their inexorable march toward faster and faster micro-chips, most of us wonder what we are going to do with all of this new computing capacity. Was the productivity miracle really just a technology bubble? If it was, and policymakers fail to realize it soon enough, we will pay the price on the inflation front as they will try to push growth past the level consistent with price stability.
Consumer Price Inflation, Various Measures
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