Growth Requires a Bit of Inflation


 
A bit of inflation is not a bad thing. In the United States, prices moving upward expose the wounds from the credit crisis that are on the mend, as the US economy continues on its road to recovery.

The evidence shows up in some national reports; consumer inflation, after stripping out food and energy prices, has edged upward over the past year and now is running just above the Federal Reserve's 2% target.

Workers' pay is also moving higher as the labor market starts to improves. Hourly earnings have grown at an average annual rate of 2% since last May and posted a 2.1% gain last month, up from a 1.8%  pace a year ago.

Home prices in a few cities, including Miami and Phoenix, have started to rise, the latest Case-Shiller index showed, as the overall index fell. In the Washington DC area, some realtors say competition has heated up, bringing multiple bids and quick sales.

Some businesses and small firms are reporting shortages of skilled labor, especially for technical positions.

The New York ISM found in March that 20% of purchasing managers had problems hiring. The National Federal of Independent Businesses said almost 33% of its firms surveyed in February had few if any qualified applicants to fill vacancies. This will likely push up wages in these sectors.

The amount of slack in the economy also appears to be lessening, the US Federal Reserve staff said in minutes last week from the March central bank meeting.

When there is lots of unused capacity in the economy, price cutting is common. If demand holds up, the narrowing of the output gap often gives companies some extra pricing power.

The most cautious US Federal Reserve policymakers are taking note. "Relative to a few months ago, I think the downside risks to the US economy have lessened," John Williams, San Francisco Fed Bank President, said last week. He was in the Fed camp casting the most doubt on whether the US recovery has staying power.

These signals of pricing gains are not enough to ring inflation's bell, and it is too soon to say they would prompt the Fed to alter its pledge to hold interest rates exceptionally low until Y 2014.

Deutsche Bank said that it expects the upward bias in consumer prices is finished. "Underlying sectors that have been driving these movements are showing signs of leveling off or reversing as we look ahead," it said in a research note, citing slower gains in rental prices and a decline in car prices.

The United States gets a new read on inflation this week when the US Labor Department releases the producer price index Thursday and the consumer price index Friday.

Both measures are seen rising by 0.3% in March, after 0.4% gains the past month. Excluding food and energy, core CPI is forecast to rise 0.3% from a 0.2% gain in February.

One reason for a higher core CPI is that the rise in energy prices over the past year is starting to get embedded in underlying prices.

Analyst calculations report that a $10 increase in the price of a barrel of Crude Oil pushes up the personal consumption expenditures price index, an alternate inflation measure closely watched by the Fed, by 0.1 percentage point after 1 yr.

The International Monetary Fund (IMF) similar estimates that a 10% increase in Crude oil prices pushes up inflation by 0.5 percentage point after 1 yr, and 5 yrs later, it still accounts for a 0.1 percentage point of the price increase, it has a lasting impact.

Last year's Crude Oil price rise now is getting built into underlying prices in the United States.

Crude Oil costs rose 35% in early Y 2011 on political turmoil in North Africa and the Middle East (MENA).

They faded some, but began rising again in October by a similar amount on political saber rattling over Iran's nuclear program.

Usually price increases are temporary, causing a 1-off hit to the economy. US Fed policymakers have said they view the Crude Oil-driven gains as passing. But a recent IMF study found the  recent recession may have changed the dynamic.

"Crude Oil price fluctuations appear to have contributed to higher inflation uncertainly since the crisis. In months of large Crude Oil price fluctuations, consumers longer term inflation expectations are spread out more widely," the IMF said in a March study.

The IMF looked at the premium paid for Treasury inflation-protected securities over Treasury notes to get a reading of inflation expectations and found that investors demanded higher returns after the crisis.

"Thus, it appears more likely that on average markets associated Crude Oil price increases with a stronger US economic recovery in the aftermath of the recent recession, thereby raising their expectations of inflation and policy interest rates simultaneously," IMF researchers said.