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TIMES BOARD OF ECONOMISTS / Irwin L. Kellner

Inflation's Back, Taking on Steam

October 04, 1987|IRWIN D. KELLNER | IRWIN L. KELLNER is chief economist at Manufacturers Hanover in New York

Don't look now, but after six years of continuous slowing in the rate of inflation, the price picture has suddenly and dramatically changed. Not only are prices--as measured by the widely watched indexes--heading up significantly faster this year than they did in 1986, the increases are likely to accelerate in the coming months for a variety of reasons.

It was too good to be true. Prices last year barely budged at the consumer level, while at the producer, or wholesale, level they fell more than they had in more than 20 years.

Falling energy prices were largely responsible--but so was an acquiescent labor force. In the face of steady declines in the unemployment rate and growing labor shortages, employment cost increases slowed to the point where the gains were the smallest on record. Job security, it seems, was uppermost in workers' minds, thanks to widespread cuts in payrolls in the wake of a number of well-publicized corporate restructurings.

As a result, workers began to lose ground in the race with inflation. In the first eight months of this year alone, the consumer price index ran up more than twice as fast as average hourly earnings. On a broader basis, total take-home pay, adjusted for inflation, has fallen below year-ago levels--the first 12-month decline since the recession year of 1980.

However, the jobless rate continued to fall and by late summer 1987 reached its lowest level since 1979. Labor shortages intensified, encouraging employees to ask for--and obtain--higher wages.

The Labor Department's hourly earnings index, which excludes wage gains caused by factory overtime and shift differentials, rose 0.4% in August--twice July's rise, and the biggest increase in eight months.

In some industries, this increase has been offset by greater efficiencies--but, in most sectors of the economy, productivity is declining, so labor costs per unit of output are rising. This means more price pressures.

Going back to the previous stage, producer prices of intermediate materials, excluding food and energy, have been accelerating. After declining at a 1.5% clip in last year's second quarter, these goods prices have been climbing at an ever-increasing pace. At the latest report, they were rising at a 5% rate in this year's third quarter--about one-third faster than the pace of the second quarter.

At the earliest stage of production, prices of industrial raw materials have shot up 36% over the past year alone; they are higher now than they have been at any time since 1981. And these commodities do not include oil, whose price is more than double its low point of April, 1986.

Some analysts have tried to minimize these increases, claiming that supplies remain in excess of demand for many commodities. However, this is more a long-run than a short-run phenomenon; at the moment, the demand side predominates.

Behind this shift lies the lower-valued dollar. It has increased the demand for many of these commodities in those countries whose currencies have risen against the dollar. At the same time, the lower dollar has increased the price of goods imported into the United States.

This alone adds to domestic inflation but, in some industries where imports are a major factor, the boost is even greater, since it enables domestic producers to raise their selling prices as well.

The lower dollar has also stimulated the heretofore moribund goods-producing sector of the U.S. economy. Exports rose 12% in the first seven months of this year, compared to last year, causing many producers to fall behind when it comes to filling orders. Backlogs have now risen 1 percentage point or more for four straight months--the longest such period of strength in nearly four years.

More purchasing agents today report paying higher prices than at any time since April, 1984, while delivery times are the slowest since July, 1984. Not surprisingly, the rate of operation of the nation's factories, mines and utilities is now the highest in 33 months.

As the economy heats up, it will sop up the excess liquidity created by the Federal Reserve these past few years, most of which has been parked in the financial markets. Unless the Fed continues to expand the money supply rapidly, this could lead to a bear market for both stocks and bonds.

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