How a Broken Link Keeps Prices Down

By Ayers, Wayne M. | ABA Banking Journal, July 1999 | Go to article overview

How a Broken Link Keeps Prices Down


Ayers, Wayne M., ABA Banking Journal


Wayne M. Ayers, chief economist, BankBoston, and chairman of the ABA Economic Advisory Committee

Suddenly fears of inflation are in the air. After an extended period of benign price reports, April consumer prices were up some 0.7% on the month. Even the so-called "core" inflation rate, a reading that excludes volatile food and energy components, posted an eye-catching 0.4% gain. These numbers clearly rattled financial markets and suggested to some that the Federal Reserve would push interest rates higher to forestall the emergence of inflationary pressures.

But are these fears really well-grounded? After all, the 1990s have, at least to date, turned in the best inflation performance in decades. And while few would argue that inflation is now a historical artifact, price pressures have become less virulent and the current business cycle expansion is a very different animal than those seen in the past.

Indeed, one such indication of this is economists' forecasting record of late. Despite widespread expectations and forecasts of a slowdown in the pace of business activity, the U.S. economy has been growing at a robust 4% percent rate for the past three years. Now with the unemployment rate at its lowest level in nearly 30 years, we are well beyond the point where, based on historical statistical relationships, wage and price inflation should be on the rise.

But not this time around. The April price numbers notwithstanding, there is virtually no evidence of the kinds of excesses and imbalances which usually produce inflation. To be sure, labor markets are stretched as tightly as they have ever been. Product markets, however, exhibit exceptional slack.

This dichotomy may be the key to understanding the current strong growth/low inflation environment. Historically, low rates of joblessness have always been associated with high rates of factory utilization. But since 1995, that well-established link has been broken. Currently, the rate of capacity utilization is now at 79.8%, a level usually seen only during recessions.

This can be explained largely by the surge in capital investment. …

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