Imagine the economy as a driver who is speeding–not recklessly, mind you, but definitely exceeding the posted speed limit.
With the road ahead clear, straight and smooth, the driver flips down his shades in the brilliant September sunshine and speeds on.
No need to worry about the economy’s traffic cop, the Federal Reserve Board. He’s holed up in a doughnut shop, enjoying an extended coffee break.
That is the curious state of the nation’s economic affairs as fall nears. The consumer price index for August, released Tuesday, proved benign, the latest piece in a remarkable economic puzzle combining low unemployment, low inflation, robust growth and higher productivity in the seventh year of an economic expansion.
Tuesday’s report–the last major piece of economic data before the Federal Reserve Board meets in two weeks to eyeball interest rate levels–virtually guarantees no action by Fed policymakers.
The consumer price index, last week’s reassuring report on the producer price index and other recent readings of the economy are also sure to intensify the debate over how long these idyllic conditions can last. Can the economy blithely continue to speed along, or will the inflation cop at long last haul himself back onto his motorcycle and slow things down?
Consumer prices in August rose less than expected, 0.2 percent, according to the Labor Department report. The Fed also reported Tuesday that industrial output jumped 0.7 percent in August, nearly double July’s rate and the highest level in 16 months,
Wall Street surged on the news, with the bond market staging one of its biggest rallies ever and stock prices soaring. Yields on the benchmark 30-year Treasury bond–which moves down as prices move up–dropped to 6.40 percent from 6.57 percent Monday, and that drove up the stock market. The Dow Jones industrial average soared 174.78 points, or 2.3 percent, to 7895.92.
So far this year, inflation has edged up just 1.6 percent. On an annualized basis, inflation is running at a 2.2 percent rate, well below last year’s gain of 3.3 percent. Factoring out food and energy prices, which can gyrate wildly from month to month, August’s gain was just 0.1 percent.
Those who buy into the new paradigm thinking that faster growth won’t fuel inflation because productivity gains justify it–and that includes Fed Chairman Alan Greenspan–aren’t always sure they understand how the economy got there. But they are convinced that traditional ways of measuring the millions upon millions of decisions that add up to the economy’s performance are missing changes that help explain this pleasant state.
Those who doubt this new thinking are confounded by data that show non-inflationary economic growth at a level higher than the tight labor market would suggest is sustainable. And each month they say, “Wait til next month” for the proof that they have been right all along.
A British magazine, The Economist, disparages the so-called new-paradigm thinking in its Sept. 13 issue, writing: “Americans love a big new idea, and a suspicion of traditional economic logic makes them especially susceptible to this one.”
“It’s been a remarkable stretch,” admitted John Hancock economist Oscar Gonzalez, noting that Tuesday’s inflation report is just the latest in a string of good-news numbers. “Economic historians may be able to explain this period some day, but right now we can only guess–and enjoy the ride.”
“We’re having a couple of golden quarters; it’s not a golden age,” insisted Tim O’Neill, chief economist for Harris Bank/Bank of Montreal, who says he is definitely “not in the new-paradigm school.”
Stephen Roach of Morgan Stanley Dean Witter, also a vocal doubter, says, “We continue to believe” that projected second-half growth of 3.4 percent “is more than 1 percentage point faster than the economy’s inflation-stable speed limit.”
Can the economy continue to grow blissfully without inflation? Roach asks, and answers a “resounding `No.’ “
Roach said he believes “our days of tranquility on the price front are now nearing an end” and the cyclical pressure of a tighter labor market plus an “outbreak of . . . worker backlash,” as evidenced by the recent Teamsters Union strike against United Parcel Service, will spur inflation.
Merrill Lynch chief economist Bruce Steinberg disagrees. He said he believes economic growth in the second half of the year will echo the first half–stronger growth in the third quarter offset by weakness in the fourth, just as a threat to overheat in the first quarter was cooled in the second.
As for wages, Steinberg sees low inflation producing real wage growth, even though nominal wage gains will remain small. This produces a “virtuous circle” that reinforces itself, he said.
Although Steinberg says the UPS settlement was “viewed by everybody as a great victory for the Teamsters,” he believes it was not inflationary, calling for a 3 percent-a-year raise for full-time workers over the next five years.
Part-time workers will get bigger boosts, but Steinberg notes there is high turnover in those ranks, which will mitigate the overall inflationary impact.
“If every wage settlement were like the UPS settlement,” he added, “we would never have any inflation problem in the U.S.”
Jerry Jasinowski, president of the National Association of Manufacturers, characterized the present economic situation “as the best of both worlds. We have robust growth and low inflation. We have every reason to believe this coveted balance between growth and inflation will continue into 1998.”
He added, “The speedup in manufacturing activity is being accounted for by faster productivity growth, which offsets pressure on prices.”
