March 3, 2005
Is inflation rising, as January’s PPI suggests, or is
it stable, as the latest CPI indicates?
Bond investors are not sure. They
sold bonds when they saw that 0.8 percent increase in producer prices for
finished goods excluding food and energy (normally called core inflation).
Investors then bought back some of those bonds when the CPI core
continued its modest 0.2 percent monthly advance.
Can we ignore the surging PPI as an aberration?
Some of those large price increases were in volatile
components of core inflation, such as vehicle and tobacco prices.
The latter changes once or twice a year while the former jumps up or
down depending upon whether manufacturers are providing discounted pricing
to stimulate sales.
In January, auto and truck dealers took off their
promotions. Sales fell sharply,
and the promotions are back, as the February report should indicate.
However, rising prices from clothing to carpets,
jewelry, mobile homes, and newspapers may reflect what I formerly called the
“catalog effect.” Every
January and July, many businesses issue product prices that they try to
maintain for the next six months.
If they think costs will rise, they bump up prices.
If costs are expected to be stable or fall, they hold prices and then
provide incentives, such as free shipping or longer payment terms (which are
not captured in the pricing surveys) to entice customers.
In the past few years, when deflation was a worry, this
catalog effect disappeared. Now
it appears to be back.
Last year’s March and April surge in commodity prices
probably spooked domestic producers. Producers
are building higher prices into
their catalogs just in case a repeat of last spring’s commodity price
surge develops this year. If
producers are wrong, as I expect, then they will use the shipping and
payment terms to be competitive.
Certainly, the failure of consumer prices to reflect
the surge in producer prices is one factor suggesting that price increases
are not yet easily absorbed by customers.
Indeed, the CPI report was even better than the headlines suggest.
Those tobacco and auto price increases were in there
(the CPI). Some higher clothing
prices also were in there. A
surprising increase in computer prices was apparent in the CPI but not in
the PPI. Yet, price declines in
lodging and public transportation (especially airlines) as well as
moderation in education and medical inflation offset those gains.
In the past three months, the core CPI rose at an annual rate of 2.0
percent, down from 2.3 percent for the past year.
Also, the sensitive crude material prices that are part
of my leading inflation indicators declined significantly for the second
consecutive month. To be sure,
intermediate producer prices showed the same 0.8 percent increase as for
finished goods, but those increases certainly also reflect a catalog effect.
There are no catalogs for crude prices.
My other inflation indicators are mixed.
Economy wide, productivity slowed to less than a 1 percent gain in
the fourth quarter. However, my
monthly indicators use the more readily available manufacturing productivity
measures, which were growing faster than the annual average as the year
Hourly wages are maintaining a modest gain of less than
3 percent, but benefit costs are continuing to grow enough to slowly push up
growth in labor costs per hour worked to more than 4 percent.
The dollar was strengthening but has stumbled in recent
days. Nevertheless, it is
stronger than at the end of last year.
Also, because of cost cutting efforts, corporate profit margins are
well above normal (usually an indication that corporations can use price
cutting to maintain market share).
Capacity utilization is growing and unemployment is
falling, but both remain well away from bottleneck levels (except for some
medical personnel and truck drivers). Excluding
energy, demand pressures remain modest.
In fact, when I combine all the indicators, the
prediction is for stable inflation. Prevailing
high energy prices probably will tilt other price increases upward, but not
But I would not totally discount that catalog effect in the PPI. It reveals that the Main Street producers have different, and higher, price expectations than Wall Street investors. Sometimes, Main Street is right.