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Fed Chairman Ben Bernanke (Win McNamee/2010 Getty Images)
Fed Chairman Ben Bernanke (Win McNamee/2010 Getty Images)

Economy Lab

Why U.S. inflation risk is subsiding Add to ...

The inflation threat in the United States is subsiding.

That's different than saying inflation is subsiding. Prices in the U.S. continued their slow climb in April, just as you would expect them to amid stronger economic growth and a surge in commodity prices. The consumer-price index increased 3.2 per cent from April 2010, the biggest gain since October 2008, the Labor Department said Wednesday. The core CPI, which excludes food and energy costs, rose 1.3 per cent on the year, the most since February 2010.

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The readings were in line the expectations of 76 Wall Street analysts surveyed by Bloomberg News. Energy costs increased 2.2 per cent from March and were 39 per cent higher than a year ago. Commodities excluding food and fuel climbed 0.4 per cent in April, the biggest jump since October 2009. Rising costs for new automobiles, apparel and other components shows companies are passing on at least some of their higher input costs to consumers.

The pass-through effect tends to be portrayed as a negative. The company owners and executives who suppressed or cut prices during the recession don't see it that way. Some inflation is natural as an economy grows. The question is whether price increases get out of control. There is little evidence that is happening. The reason: inflation is burning itself out by curbing economic growth.

The Federal Reserve Bank of Philadelphia's second-quarter survey of 44 professional forecasters cut the outlook for economic growth in the April-June period to 3.2 per cent from 3.5 per cent in the previous survey. For the year, the Philly Fed poll predicts annual average growth of 2.7 per cent in 2011, down from 3.2 per cent. The forecasts estimate that U.S. gross domestic product will advance at an annual rate of 3 per cent in 2012, 2.8 per cent in 2013 and 3.3 per cent in 2014 - all slightly lower than the previous estimates.

Higher prices are limiting demand, which will in turn limit companies' ability to raise prices. A separate Labor Department report Friday showed that inflation-adjusted wages fell 0.3 per cent in April, the fifth decrease in the past six months. Real wages declined 1.2 per cent on the year, the biggest 12-month drop since September 2008.

Evidence of slower global economic growth is taking the froth out of commodity prices; the cost of crude, for example, has dropped 13 per cent this month on the New York Mercantile Exchange, according to Bloomberg, to around $99 (U.S.) a barrel.

There's an argument to be made that the price could fall further, depending on the direction that speculators head.

While the Senate Finance Committee's grilling of the executives of the U.S. five biggest oil companies Thursday was mostly theatre, there were periodic moments on enlightenment. One came when Maria Cantwell, a Democratic senator from Washington, pushed Exxon Mobil Corp. boss Rex Tillerson on how big a role speculation played in the current oil price. The exchange went like this:

Ms. Cantwell: "What do you think the price would be today if it was based on fundamentals of just supply and demand?"

Mr. Tillerson: "Well, again, it's, if you were to use a pure economic approach, the economists would say it would be set at the price to develop the next marginal barrel."

Ms. Cantwell: "What do you think that would be today?"

Mr. Tillerson: "Well, it's pretty hard to judge, but it would be, you know, when we look at it, it's going to be somewhere in the $60 to $70 range ... if all things were according to economics and people didn't risk manage and they didn't do everything else that they do, it would be set at the marginal cost of the next increment of supply."

Federal Reserve Chairman Ben Bernanke's message has been that the price effects of the surge in commodity prices will be transitory. This doesn't mean he thinks those prices will plunge. But he does think there is lots of room for the price increase to slow, or even slip a little. That will take the steam out of the inflation rate.

For the Fed, the most important break on inflation is expectations. As long as consumers are confident prices will remain steady, inflation should remain in check. And inflation expectations are steady. The University of Michigan's consumer sentiment index showed Friday that 1-year inflation expectations fell to 4.4 per cent in May from 4.6 per cent in April, while five-year inflation expectations were little changed at 3 per cent versus 2.9 per cent the previous month.

This should allow Mr. Bernanke more space to work on the real threat to the U.S. economy, joblessness. The Philly Fed's survey predicts the unemployment rate will average 8.7 per cent this year, 8.1 per cent in 2012, 7.5 per cent in 2013 and 7 per cent in 2014.

The Fed has a dual mandate: Price stability, which the central bank loosely defines as inflation of about 2 per cent, and maximum employment, which policy makers say is around 5.5 per cent.

On one of those mandates, the Fed is seriously off target. And it isn't inflation.

Follow on Twitter: @CarmichaelKevin

 

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