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Bernanke's Inflation Dilemma


By some measures, prices are soaring. By others, they're in check. What's a Fed chief to do about rates?

Should we be scared of inflation? Consumer prices are up 5.6% over the past year, the biggest jump since 1991. But oil prices are heading down, and commodities such as corn, aluminum, and copper are well off their peaks.

In fact, the inflation picture is as muddled as it has ever been. For every statistic that shows inflation heading up, there's another that shows inflation on the downswing. Indeed, the most important price in the economy—the average hourly wage—is rising at a snail's pace, as workers get squeezed by higher unemployment.

This lack of clarity puts Fed Chairman Ben Bernanke and the other members of the policymaking Federal Open Market Committee in a bind. When they next meet on Sept. 16, they won't know whether inflation is out-of-control or tame—so they won't know whether interest rates need to be raised or even lowered.

To see the statistical mishmash, look at the price of gross domestic purchases—that is, what we buy as a nation, including imports (chart). That price is up by 3.5%, compared with 2.6% a year ago.

Worrisome, right? But the inflation figures for gross domestic product—the goods and services we make here and consume or export abroad—tell a different story. That widely cited rate has fallen from 2.8% a year ago to 2% today, the lowest level since 2002.

NEW NUMBERS

Or consider producer prices, which are prices received by domestic companies that are the original "producers" of a good or service. On Aug. 19 the Bureau of Labor Statistics announced the Producer Price Index for Finished Goods was up a huge 9.8% over the previous year.

But hidden at the back of the same report are some new numbers the BLS has recently started calculating: overall producer price indexes for the service sector, which makes up a much larger share of the economy than goods. In particular, the BLS now provides a price index for what it calls traditional services, including industries from banking to legal services to travel agencies to hotels to health care to Web search portals.

Inflation, as measured by the producer price index for traditional services, is running at only 0.4% over the last year, down from 1.8% in December 2007. In other words, there's no sign of inflation being passed through to the service sector so far.

Wage increases, too, are slowing. In the second quarter of 2007 average hourly wages and salaries were rising at a decent 3.9% clip for all private sector workers. Now the same data show a 2.6% increase, even including top managers. Does that seem like runaway inflation?

Here's one final thing for Bernanke and his crew to think about as they debate interest rates. In the second quarter both the Japanese and Eurozone economies contracted. If the global slump continues, and U.S. unemployment rises, businesses and workers may end up with little pricing power. Zero inflation, anyone?

For more from Michael Mandel on the Fed's dilemma, watch a video report at businessweek.com/go/tv/fed.

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