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Some Good News on Inflation
By
Wednesday, January 18, 2006
Today, the Labor Department reported that the Consumer Price Index decreased 0.1 percent in December on a seasonally adjusted basis, thanks to lower energy prices. The consensus forecast was 0.2 percent, and my forecast published by Reuters was for no change.
The core CPI, consumer prices less food and energy, rose 0.2 percent. The consensus forecast and my forecast published by Reuters were 0.2 percent.
Consumer prices fell at a 1.6 percent annual pace in the fourth quarter. Clearly, inflation poses no real threat but overly aggressively Fed interest rate policy could torpedo the economic expansion.
Food prices were up 0.2 percent, less than for the previous three months, as the disruptions created by hurricanes Katrina and Rita subside. The upward push on food prices created by hurricanes Katrina and Rita will disappear in the months ahead.
Gasoline prices fell in December but gasoline prices will push up inflation in January. The average retail price of gasoline was $2.23 per gallon in December, down 7 cents. In January, retail prices for gasoline will post 20 to 25 cents increase and average about $2.45 per gallon.
Other than energy prices, inflation will moderate in the months ahead, owing to slowing retail sales and price cuts for cars and trucks.
Retail sales posted only modest gains in December. This winter, consumers strapped by higher gasoline prices and heating bills, are hunting for bargains; and retailers and manufacturers in the United States and China are being forced to trim profits.
Price cuts by General Motors will force lower prices throughout the automobile industry.
Overall, there is no evidence that higher energy prices are spreading to other sectors of the economy in any meaningful or alarming way.
The Fed should stop raising interest rates soon. Fed policy can have little impact on gasoline, heating oil and natural gas prices, as these are primarily driven by conditions in international energy markets and the weather. Oil prices are likely to rise as the Chinese and other Asian economies expand rapidly. Fed efforts to moderate domestic energy prices would only penalize U.S. growth to accommodate Chinese demands on global oil markets.
Fed policy can only significantly affect inflation outside the energy sector, and nonenergy price inflation remains modest and under control.
The Fed will likely increase the federal funds rate to 4.5 percent on January 31; however, if new Fed Chairman Ben Bernanke pushes up interest rates too much further, he risks turning an economic slowdown into a recession. This is the mistake a less experienced Alan Greenspan committed in 1990.
The housing market is weakening, and prices will moderate or fall this winter. In 2006, housing prices will likely fall about 5 percent. If the Fed pushes up interest rates too much, housing prices could plunge more than 10 percent, and this mortally wound the economic expansion.
If the Fed pushes interest rates too far, deflation, not inflation will be the problem.
Peter Morici
Professor
Robert H. Smith School of Business
University of Maryland
College Park, MD 20742-1815
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