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U.S. Consumer Prices data indicates the Fed should not raise rates - - Dr. Peter Morici
By Professor Peter Morici, Robert H. Smith School of Business, University of Maryland
Sep 15, 2005, 15:28
Professor Peter Morici is a recognized expert on international economic policy, the World Trade Organization, and international commercial agreements. Prior to joining the university, he served as director of the Office of Economics at the U.S. International Trade Commission.
Today, the U.S. Labor Department reported that consumer prices rose 0.5 percent in August; however, the core inflation index--prices for products other than food and energy--rose only 0.1 percent.
Importantly, during the first six months of this year, the core rate increased at a 2 percent seasonally adjusted rate, as compared to 2.2 percent for the same period last year. Higher productivity growth, new technologies, and more intense domestic and international competition are driving inflation, outside the energy sector, down.
Energy prices are driven by conditions in international markets, and more recently, but the outages created by Hurricane Katrina. As the latter subside, energy prices and pass throughs in transportation services will subside, and inflation will prove quite tame.
Coupled with the recent reports that economic growth is slowing, retail sales are falling and wholesale price inflation remains tame, these data indicate the Fed has no need to raise interest rates.
Hurricane Katrina has jacked up prices for natural gas, gasoline, other petroleum products, transportation services, building materials, and certain food products; however as Gulf refineries, natural gas production and ports come back on line, these price increases will reverse. The prices for most of these products are set by global markets, and U.S. rebuilding needs will not alter those fundamentals once the refineries, related plants, and ports reopen.
As noted, core consumer prices rose 0.1 percent in August, and wholesale prices for final consumer goods, less food and energy fell -0.1 percent in August, indicating future increases in core consumer prices will be quite small.
Taken together, prospects for a reversal of recent energy price increases and the absence of other fundamental inflationary pressures indicates inflation provides no significant justification for raising interest rates further at this time.
Given the fragile state of the economy in the wake of Hurricane Katrina, the Federal Reserve should not raise interest rates when it meets September 20.
Moreover, the economy was already slowing before Katrina, and the damage will slow growth further into the first half of 2006. If the Fed raises rates, it risks driving the economy into a recession.
Despite years of economic expansion, inflation outside the energy sector remains largely under control. This is not surprising, because economic growth is slowing, and outside the oil and natural gas sectors, additional productive capacity is readily available. Manufacturing and retailing continue to have much slack capacity, and skilled labor remains abundant.
Further, manufacturers continue to enjoy historically strong productivity growth and face intense competitive pressure from a growing range of Chinese and other Asian exporters. Slack capacity, higher productivity and more competition from imports have eliminated pricing power for most manufacturers of consumer goods. Look at autos and appliances.
Although unemployment is 4.9 percent, many prime working age Americans are standing on the sidelines, as the labor force participation rate is much lower today than in 2000. Wage increases have been small and barely kept up with inflation, indicating skilled labor remains abundant. Moreover, layoffs in airlines, autos and other industries hit by restructuring are adding to this readily available pool of skilled workers.
Retailing continues to be intensely competitive. Internet firms are now pressuring traditional brick and mortar stores much as imports are pressuring General Motors and other manufacturers.
Other service activities are being pressured by similar technological changes and new competition from abroad.
It all adds up to low domestically generated inflation. Most inflation results from conditions in international petroleum markets and Hurricane Katrina. Federal Reserve policy can little affect international oil markets or the weather.
Shortages created by the closure of the Port of New Orleans and the damage caused by Katrina are pushing up prices for building materials and some other commodities such as coffee, paper and produce. Most of these price increases are temporary and will reverse, and further increasing interest rates would have little effect on their long-term inflationary consequences.
The economy already began slowing in the second quarter, and if the Federal Reserve takes no further actions to raise interest rates, Katrina will slow economic growth further for the balance of the year. The spike in gasoline prices is already curtailing retail sales. In many ways, higher gasoline prices are doing the work of higher interests. Higher gas prices are slowing the economy, and dampening inflation for many other consumer goods.
By increasing interest rates further, the Federal Reserve risks turning an economic slowdown into a recession while doing little to quell inflation.
The Federal Reserve should pause until more is known about the full consequences of Hurricane Katrina.
