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Hard Facts about Inflation

Author: Roger M. Kubarych
April 14, 2004
Council on Foreign Relations


For some time, evidence has been mounting that powerful forces are gathering that will tend to lift the US rate of inflation. Until recently, these forces have been mainly apparent among the leading indicators of inflation. Those include soaring commodity prices, a lower value of the US dollar in the foreign exchange markets, rising capacity utilization rates in industry, increased delivery delays, and declining unemployment rates, especially for experienced workers.

But with the publication of two important price reports, it is now clear that these upward pressures are beginning to be incorporated in important inflation indexes. Last week, the report on US export prices revealed that US firms have increasing pricing power in the most competitive marketplace, the global markets. Non-agricultural export prices have risen by over 0.6% per month so far this year, or a seasonally adjusted annual rate of about 8%.

US Export Prices
% change, seasonally adjusted annual rate


Q1 2004

March 2004-March 2003

Agricultural exports



Non-agricultural exports



This week, the consumer price index for March was published, showing a significant acceleration of inflation. The overall rate was up 0.5%, while the core rate, excluding food and energy, was up 0.4%. For the first quarter as a whole, the overall rate of consumer price inflation is up at a 5.1% seasonally adjusted compound annual rate. That is a marked acceleration from the 1.7% increase over the past twelve months. Similarly, the core rate has accelerated to a compound annual rate of 2.9% during the first three months of 2004, an acceleration from the 1.6% increase over the past twelve months.

Consumer Price Index
% change, seasonally adjusted annual rate


Q1 2004

March 2004-March 2003




Core, excluding food&energy



The public description of incipient inflationary pressures by senior officials of the Federal Reserve has not taken account of this recent evidence. For instance, Federal Reserve Board Vice-Chairman Roger Ferguson, in a speech he gave on April 8, 2004, made the following statement: “Although prices for some commodities have risen, underlying consumer price inflation only now looks to be stabilizing at a low level after falling for some time.”

In fact, commodity prices have been soaring, and not just for “some” commodities. Virtually every commodity is up strongly in the past six months. Accordingly, both the IMF and the CRB commodity price indexes are up over 20% during that time. And the acceleration of the core rate of consumer price inflation during the first three months of 2004 contradicts the notion that price inflation is stabilizing at a low level.

In his speech, Ferguson went on to argue as follows: “The real Federal funds rate is now close to zero, and market participants expect it to remain near that level for a while.”

That assertion is not supported by the data. The real Federal funds rate is now substantially negative by every measure of inflation. While market participants differ about the timing and magnitude of eventual Fed tightening moves, the general expectation is that the real Federal funds rate will remain negative this year because the Fed is not thought to be ready to tighten policy sufficiently to produce a positive real Federal funds rate any time soon.

Ferguson’s colleague Fed Governor Donald Kohn, who was formerly the top staff assistant to Chairman Greenspan, gave a slightly less complacent reading of the inflation outlook in his speech of March 26: “Overall, the tenor of the inflation outlook has shifted over recent quarters. Solid growth in economic activity, higher prices in some sectors, and hints of the stabilization of overall inflation, along with perceptions by businesses that ‘pricing power’ may be returning, are marking a transition from asymmetric risks of additional disinflation to more nearly balanced risks of rising and falling inflation.”

Even this version of the Fed’s “party line” is out-of-date. There is simply no evidence of disinflation risks at the present time.

The following table shows the main swing factors in the consumer price index. For each of the components that significantly pulled down the rate of inflation over the past year, prices have either turned up in the past three months or are falling much less rapidly.

Disinflationary Factors Dissipating
% change, seasonally adjusted annual rate


Q1 2004

March 2004-March 2003M

New motor vehicles



Used vehicles



Fuel Oil



Home furnishings






Telephone services



Information technology



Personal Computers



Everything else is rising in price, domestic produced goods and services, along with international products. US non-petroleum import prices are up 5.6% at an annual rate so far this year. Over the past twelve months, by contrast, they rose only 1%.

It is likely that the Fed will try to smooth the troubled waters in the bond market by reminding investors that there is still slack in the economy and that, in any event, one or two months of bad inflation numbers (or of fast job growth, for that matter) is insufficient to draw firm conclusions about trends. Such soothing statements may work for a while.

But very soon the Fed will drop the notion that there are disinflation risks equivalent to the upside risks on inflation. How soon after that they will start to hike the Federal funds rate is unknown, but the odds are definitely rising that they will not be able to wait until after the November election.

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