Estados Unidos - Inflation’s last hurrah – The Economist

Aug 21st 2008 | WASHINGTON, DC, From The Economist print edition

Sinking standards of living explain why the inflation news is likely to get better

THE inflation news in America has been ugly. Consumer prices rose 5.6% in the year to July, the fastest clip since 1991. Producer prices rose 9.8%, the most since 1981. Fuel and food are mostly to blame; but even excluding them “core” consumer and producer inflation have both picked up.

This may, however, be as bad as it gets. Not only have international commodity prices turned down decisively, but America’s state of near-recession means that it will be hard for workers to secure wage rises that match, let alone exceed, the inflation rate. That is a painful but unavoidable result of Americans’ changed economic circumstances: what they buy has become more expensive relative to what they sell.

Commodity prices have been the cause of most of the increase in total inflation, and probably also in core inflation, which has risen, with a lag, as producers pass higher commodity costs on to consumers. This is particularly true of energy-intensive things like airline fares, which have risen by 20% in the past year.

The effects of passed-on energy costs, as well as higher import prices stemming from a weaker dollar, have probably not run their course, so core inflation may edge higher in the months to come. But then both it and total inflation will probably head down. This will also in part be thanks to another bit of ugly economic news: falling real wages. Hourly private-sector wages were up only 3.4% in the 12 months to the end of July. Adjusted for inflation, they were down more than 2%.

Falling real wages are exhibit A in the election-year debate over middle-class angst. They are also the reason why the current bout of inflation differs from that of previous decades. For higher inflation to become dangerous a wage-price spiral is required, and without higher wages, there is no spiral. Wages in America are actually growing more slowly than a year ago.

If Americans produced more of the oil and other commodities they consume, the benefits of higher prices would flow to American firms who could thus pay higher wages. But the benefits instead flow primarily to producers overseas. High inflation and low wage growth, painful as they are, are necessary for Americans to adjust to the fact that they are facing a “terms of trade” shock: relative to their trading partners, their standard of living must go down. A simple illustration of this is that the government’s price index of gross domestic product—what Americans produce—rose 2% in the year through the second quarter, a slowing from a year earlier. Prices of gross domestic purchases—what Americans buy—rose 3.4%, an acceleration.

A wage-price spiral could develop should workers and firms conclude higher inflation is here to stay and adjust wages to compensate, one reason why the Fed watches out for inflationary expectations so closely. But rising unemployment and spare capacity suggest that workers who want higher wages will be hard pressed to win them. Firms will, equally, be hard pressed to raise prices enough to recover their higher input bills. A glut of empty houses and flats will restrain rents, a big chunk of the consumer-price index. Martin Barnes of the Bank Credit Analyst, a research service, thinks the economy will grow more slowly than its capacity could allow at least until the end of 2009. At that point, the economy will be operating at 4% below its potential, the biggest such “output gap” since 1983.

The Fed broadly shares this view. So although it may continue to worry publicly about inflation, it is unlikely to seek to suppress it with higher interest rates, at least before the end of this year. By then, the picture could look a lot better.