Academic journal article ABA Banking Journal

Looking in the Right Places

Academic journal article ABA Banking Journal

Looking in the Right Places

Article excerpt

THE RECENT SURGE IN COMMODITY prices--most notably oil--has taken a toll on the economy. It probably subtracted half a percentage point from real GDP growth in 2004 and definitely redistributed wealth across industries. But a persistent rise in inflation is not among its outcomes.

In fact, history provides scant evidence of a linkage between commodity prices and inflation, aside from the price of the commodities themselves. Comparing a "core" inflation measure preferred by Federal Reserve officials (the deflator for personal consumption expenditures, excluding food and energy) with a broadly based index of commodity prices (from the Commodity Research Bureau) yields a dismally weak correlation over the past 45 years. Tinkering with lags and focusing on subintervals helps a bit, but since the start of the 1990s, the relationship has actually been inverse. (Rising commodity prices tend to coincide with, and precede, declines in core inflation.)

One explanation for this relationship is that central bankers have learned to read the signals of incipient price pressures and tighten policy accordingly. Another explanation emphasizes the diminishing role commodities play in our economy. In 1948, for example, goods accounted for 68% of consumer spending, but now that figure is down to 40%.

Regardless of the explanation, another indicator has proven far more reliable: unit labor costs. Defined as the labor-related cost to produce a given unit of output, this metric has demonstrated a far tighter, positive relationship with core inflation. …

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