Weakening demand will eventually cool inflation, they say
(WASHINGTON) A clutch of distressing US economic data on Friday rekindled fears of 1970s-style stagflation, but the current bout of slow growth and rising costs should be short-lived.
While there is little hope of a quick reprieve for US consumers coping with petrol around US$3 per gallon and rising costs for groceries ranging from soup to diapers, the good news is that conditions are unlikely to worsen, and slackening demand will eventually cool inflation.
‘We’re about to find out if high prices are their own cure,’ said Citigroup economist Steven Wieting, adding that higher prices have already eroded real wage gains and put a damper on consumers’ discretionary purchases.
Mr Wieting and other economists argue that higher prices will inevitably curb demand, and as demand slows, companies will end up absorbing more of the pricing pressure. While energy costs may not fall dramatically, they probably won’t rise as fast as they did last year. In January, petroleum import prices jumped 67 per cent on a year-over- year basis, Mr Wieting noted.
Friday’s economic data showed manufacturing growth in New York fell to its weakest since April 2003, import prices rose much more sharply than anticipated, and the Reuters/University of Michigan Surveys of Consumers index hit a 16-year low while inflation expectations spiked.
‘The latest set of US numbers will play to market talk of stagflationary tendencies,’ said Alan Ruskin, chief international strategist at RBS Greenwich Capital.
Still, former US Federal Reserve chairman Alan Greenspan said on Thursday that stagflation was ‘too strong a term for what we are on the edge of’, adding the likelihood of a US recession was ’50 per cent or better’.
His successor Ben Bernanke disagrees on the recession prediction and thinks inflation will moderate in the coming quarters.
He is far from alone on the inflation prediction.
Lakshman Achuthan, managing director at the Economic Cycle Research Institute, said his group’s future inflation gauge remained in a downtrend, even as its weekly index of leading economic indicators hit recessionary levels.
‘Consumers have been losing the battle at the pump, where gas prices have been high, but winning the war on inflation at the checkout counter, where in spite of higher import prices, stores like Wal-Mart are making repeated rounds of price cuts to keep consumers purchasing,’ he said.
With wheat hitting an all-time high of US$11.53 per bushel and oil creeping back towards US$100 per barrel, corporate profit margins are hurting.
Martin Baily, a senior fellow at the Brookings Institution and former economic adviser to President Bill Clinton, said there was one key ingredient missing from the current episode of stagflation – rising wages.
It is the vicious circle of rising prices leading to wage increases and still higher prices that has marked previous severe episodes of stagflation like the 1970s.
Citigroup’s Mr Wieting said that unlike that period, labour unions have limited negotiating power now, and are unlikely to have much success pushing for big cost-of-living raises.
‘I don’t know anyone who gets a higher wage because the cost of driving has gone up,’ he said.
Source: Reuters (Business Times 18 Feb 08)