Everything You Ever Wanted to Know About Inflation. GUEST COLUMN
WASHINGTON reported last week that the United States consumer price index rose 5.1 percent over the past 12 months. Although the range of inflation rates at home and abroad is wide, there's also an unmistakable global tendency toward acceleration. An uncontrollable spiral is unlikely, but inflation will make it harder for interest rates to fall and will require some adjustments to the US dollar exchange rate. On the home front, the national CPI grabs the headlines, even though the cost of living is rising twice as fast in some parts of the country as in others. Gains are smallest in the South (about 4.5 percent) and largest in the Northeast (about 6 percent). Among major cities, Dallas's 2.9 percent is the lowest and Boston's 6.2 percent is the highest. There are disparities within the same state: 5.0 percent in Los Angeles and 5.6 percent in San Francisco. And there are differences between nearby cities: Baltimore's 4.3 percent versus Washington's 5.8 percent. Finally, most of these rates are about a percentage point larger than a year ago.
International CPI trends show both a wider range and more acceleration. During the past year, inflation has doubled, from 4 percent to 8 percent, in Britain and tripled, from 1 percent to 3 percent, in West Germany. Japan is poised for a CPI takeoff that some observers expect will soon reach 3 percent, versus the 1 percent of the past two years. Although 3 percent in Germany and Japan may not sound like much, everything is relative. To the Germans, who can't forget the chaos caused by the hyperinflation of the 1920s that helped push Adolf Hitler into office, the acceleration is alarming.
Why have consumer prices been picking up speed? There are three main reasons: oil, food, and prosperity. Oil prices have been climbing recently, in contrast to 1986, when their collapse helped hold the US CPI rise to mere 1.1 percent. Last year's drought and the prospect of another dry spell this year are pushing up food prices. Finally, the long economic expansion has cut unemployment and raised factory operating rates throughout the world. This has been pushing up wages and profit margins.
Will inflation continue to accelerate? The probable answer at home and abroad is yes, but only a little bit more. The US price index will top out at about 5.5 percent, well below the 12 to 13 percent seen less than a decade ago. Of course, this requires cooperation from food costs (which could be a little iffy) and oil prices (which already seem to be flattening out). Stable inflation also requires a moderation in global economic growth, a process that has already begun in the US.
Within the US, the diversity of cost-of-living increases has some important consequences. In some areas, such as the Northeast, inflation is cooling growth prospects. Workers from other parts of the country find it difficult to move to regions where the cost of living is high and rising rapidly. Another consequence is that cost-of-living adjustments linked to the national CPI, such as those found in labor contracts and social security checks, may go further in some parts of the country than in others.
The large international inflation disparities are likely to require compensatory exchange-rate changes. If inflation means that production costs rise 4 percent faster in the US than Japan (US CPI of 5 percent versus Japan's 1 percent), then the dollar would have to depreciate about 4 percent a year to keep US competitiveness from eroding. That is, the dollar should weaken compared with the yen. The problem is that it has been strengthening.
The global acceleration of inflation is also pushing up foreign interest rates, adding a major complication to the current US situation. In a world of increasingly integrated money and capital markets, it is difficult for US interest rates to fall when foreign rates are rising - even if, as most economists expect, US economic growth and inflation both moderate.
Inflation that stabilizes at 5.5 percent should not derail the US recovery. Yet, even though stable, the rate is high enough that even a little more acceleration could cause problems.
Nonetheless inflation - including the boost in house prices - may have its bright side. You can live in a more expensive neighborhood without having to move....