U.S. Economy May Be Failing Greenspan Test for Stable Prices
U.S. Economy May Be Failing Greenspan Test for Stable Prices
Nov. 3 (Bloomberg) -- At a 1996 Federal Reserve meeting, Chairman Alan Greenspan gave his definition of price stability: when consumers and executives don't have to worry much about inflation when making decisions. By that standard, the U.S. economy may be failing his test.
``I don't think under Greenspan's definition we have price stability,'' said Allen Sinai, president of Decision Economics in New York. The Fed ``may be more than willing to trade off less growth for price stability getting back in line.''
The 79-year-old chairman testifies before Congress today on his outlook for the economy, just two days after the central bank raised the benchmark interest rate to the highest since June 2001 and said more increases are ahead. The quarter-point jump to 4 percent, the 12th in a row, is part of Greenspan's strategy to tighten borrowing rates at a ``measured'' pace to head off faster inflation.
Rising energy prices and devastation after Hurricanes Katrina and Rita ``temporarily depressed output and employment,'' the FOMC said Nov. 1. Crude oil prices have risen 20 percent, and natural gas about 40 percent, from a year ago. Even so, the Fed's statement said inflation outside of energy and food ``has been relatively low in recent months and longer term inflation expectations remain contained.''
Price Increases
Economists and executives said that may be changing as companies as diverse as Procter & Gamble Co., the maker of Pampers diapers and the largest U.S. household goods company, and automotive-glass supplier PPG Industries Inc. try to push through price increases.
``We have got to do something to pass these energy costs along,'' said Joseph Robinson Jr., president of Robinson Foundry Inc. in Alexander City, Alabama, a supplier to General Motors Corp. and other automakers. While some smaller customers have accepted price increases because of the foundry's rising costs for natural gas and electricity, he said automakers resisted by threatening to go to overseas suppliers.
Whatever Greenspan has to say today about inflation and the effects of Hurricane Katrina on jobs and growth, members of Congress said they plan to seek his views on other issues such as government spending. His term ends Jan. 31 after 18 years as Fed chairman, and his testimony at 10 a.m. today to the Joint Economic Committee will be one of his last to Congress.
Meeting Congress
``I am always interested in what Chairman Greenspan has to say,'' Representative Carolyn Maloney, a New York Democrat on the panel, said in an e-mail. ``Large budget and trade deficits and mounting debt make it harder for the Fed to play its proper role in assuring sustainable economic growth with low inflation.''
Greenspan's definition of price stability remains a ``useful, though non-explicit'' way of characterizing when inflation is low, Fed Bank of Chicago President Michael Moskow said in a Sept. 26 speech.
More businesses are trying to find ways to pass the energy prices on. Pittsburgh-based PPG said Oct. 26 it will raise prices on glass supplied to automakers by 10 percent as of Jan. 1 due to the ``magnitude and long-term nature'' of rising energy and raw materials prices.
Cincinnati-based Procter & Gamble's quarterly profit rose 4.5 percent and Colgate-Palmolive Co.'s increased 5.5 percent after the companies raised prices and added new products in the three months ended Sept. 30. The Federal Reserve Bank of Philadelphia said Oct. 20 that its measure of prices received by area factories rose last month to the highest level in a year.
Home-Equity Borrowing
To maintain their pace of spending and to help compensate for higher prices, Americans continue to borrow against their home equity. The practice is likely to slow as interest rates continue to rise and may result in a weaker expansion next year, economists said.
Freddie Mac, the second-biggest mortgage purchaser, estimates homeowners will extract $204 billion through cash-out refinancing this year and just $114 billion next year.
``If they have to ring some inflation out of the system, the initial list of victims has to include housing markets,'' said Carl Tannenbaum, chief economist at LaSalle Bank in Chicago. ``You have a risky period for consumers for the next six to eight months.''
Energy Costs
So far, broad inflation barometers show companies having only mixed success in passing along price increases to consumers. The Fed's preferred broad inflation measure, the personal consumption expenditures price index, rose 2 percent for the 12 months ending September. That is close to the upper limit for Fed officials who have specified a numeric goal.
Consumers' inflation expectations also are starting to be shaped by energy costs, further evidence that Greenspan's definition of low inflation may no longer hold.
Households expect inflation to rise 4.6 percent over the next year, according to the latest University of Michigan consumer survey, the highest reading since 1990. Expectations about where inflation may be in five years rose to 3.2 percent, the highest since January 1997.
While for now wages are lagging inflation by some measures, one of the Fed's concerns is that eventually workers will try to demand higher pay if they think prices will keep rising.
Rising retail costs ``will take some of the focus away from health-care and back on to wage increases,'' said Gordon Pavy, collective bargaining coordinator at the AFL-CIO, a labor federation which encompasses 53 unions covering 9 million employees in industries such as communications, teaching and government workers.
``The growth of labor compensation does not appear to be accelerating noticeably,'' Fed Governor Donald Kohn said in an Oct. 19 speech. ``But I will be paying close attention to developments in costs, as well as in prices, as I update my inflation forecasts in the future.''
To contact the reporter on this story: Craig Torres in Washington at Ctorres3@bloomberg.net
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