WASHINGTON -- Is inflation dead?
Perhaps not, but for now it has been beaten to the ground and is barely twitching.
In fact, the rate of inflation may be much lower than the numbers show.
Federal Reserve officials and private analysts agree that the official figures showing inflation rising at an annual rate of 3% overstate changes in price levels for businesses and consumers.
They are now in general technical agreement that the actual rate of inflation as measured by the Labor Department's consumer price index may be as low as 2%, or possibly even 1%.
The same message is being sent by commodity prices and other measures that Fed officials now scrutinize as alternatives to the price index.
In inflation is much lower than is generally believed, some analysts say, the economy may actually be doing a little better than people think. The official data could be overstating price increases at the expense of growth, because official U.S. figures for gross domestic product are adjusted for price changes.
It could also mean that the government has been shelling out billions of dollars a year in entitlement benefits that do not truly reflect the cost of living.
At the same time, there could be more room for the Fed to keep short-term rates down if market participants accept the view that price pressures are only a feeble threat.
Earlier this month, Federal Reserve Board Chairman Alan Greenspan openly proclaimed near victory over inflation in a speech to bankers in Tokyo. "The true underlying rate of inflation in today's world may not be far from what I would call price stability," said Greenspan.
This one-sentence statement that Fed policymakers are close to one of their long-sought goals was not something Greenspan would have dared to utter as recently as last December when inflation was still running over 4%.
In the short run, the Fed could be signaling a rationale for lowering short-term interest rates again, said Neal Soss, chief economist for First Boston Corp. If the market accepts the view that inflation is below 3%, which is the current federal funds rate, then another cut in rates would not mean crossing the psychological barrier of negative real interest rates.
Economic Nirvana
More broadly, economists say that Greenspan may have something to crow about. Under a regime of price stability, prices can still fluctuate, and prices of some goods such as oil and food may still move on swings in supply or changes in the weather that cannot be influenced by economic policymakers.
But on balance and over a period of time, price stability allows consumers and businesses to stop building expectations of higher prices into their thinking when they invest and buy. If achieved, it is a state of central bank nirvana that the United States last saw in the early 1960s.
The most widely used measure of inflation is the Labor Department's Bureau of Labor Statistics' consumer price index, a venerable indicator created by the government back in World War I. It is used to determine annual cost-of-living adjustments for Social Security recipients and federal retirees, as well as wage adjustments for many private sector workers.
The index is based on a fixed basket of prices of food, clothing, housing, transportation, medical care, and other goods and services that people buy in day-to-day living. Labor officials collect data for the index in 91 urban areas around the country and from some 21,000 retail stores and other service outlets ranging from supermarkets to department stores, gas stations, and hospitals.
Bureau officials, aware of criticism of their efforts to track prices, try to stay as accurate as they can. Data on food, fuels, and a few other items are collected monthly in all 91 locations, and prices of other goods and services are collected monthly in New York and a handful; of other big cities.
In addition, the bureau follows the technical literature among economists on the accuracy of price surveys, and it regularly refines its methods. The most recent overhaul, which involved sampling procedures and other changes, came in 1987.
Private experts insist the government data are flawed, based on their own recent findings and research that goes back as far as the 1930s. The government cannot keep track of what is going on, they say, in a dynamic and rapidly changing consumer marketplace where prices of products and services come and go.
Perhaps the most widely known expert on the subject is Robert J. Gordon, chairman of the economics department at Northwestern University, in Evanston, Ill. Gordon declined to be interviewed, but in a research paper published in June, he identified several different ways that the consumer price index results in an upward bias in reporting on price changes.
"If the CPI overstates the rate of increase of a pure cost-of-living index, then workers and retirees are being overcompensated for inflation," he wrote. "The accusation that the CPI systematically overstates the increase in the cost of living, and thus leads to an understatement of increases in the standard of living, is serious but longstanding."
Gordon and other critics say the consumer price index fails to keep up with new products and services as they are brought into the consumer marketplace. With model changes, new features, and technological improvements, consumer may end up paying more, but they also end up getting something more for their money.
Personal computers, with their constantly changing models and software at lower prices, are an example. So is medical care. Its costs are the biggest source off inflation within the price index, but the changing technology constantly adds new services and treatments that give patients better care than they got a few year ago. In some cases, lives are prolonged.
Historically, the government has often delayed putting new product in the index.
Gordon says consumers also manage to innoculate themselves against price increases by waiting and bunching together their purchases of goods when they go on sale. A men's clothing store, for example, may post regular prices most of the year, but cost-conscious customers end up doing most of their buying during sales periods.
Moreover, analysts say there has been a major change in the retailing business. While sales at conventional stores such as Sears have languished, sales of everything from kitchen goods to furniture at discount retailers such as WalMart and Ikea have flourished.
Critics say these discount purchases are sometimes scored by the government as purchases of inferior product and services when in fact consumers are getting comparable items at a savings.
Labor Department officials try to keep up with changes in the marketplace by adjusting their survey procedures. In the case of government-mandated changes such as airbags, for example, the higher prices are counted entirely as quality improvements and do not add to inflation. And officials have begun to try to measure quality changes in clothing.
Marshall Reinsdorf, an economist with the bureau's office of economic research, disagrees with critics who say the government is failing to take into account the shift by consumers to discount retailers.
Still, bureau officials concede that their price index is overstating changes in the cost of living. "To me it makes sense that we're understating quality improvements from new goods and things of that nature, because they really don't measure the quality improvements very well," said Reinsdorf.
He estimated that overall, the consumer price index may be overshooting price level changes by up to half a percentage point a year.
Refining Measurements
But others say the price measurement problem is more severe. "On balance, I think most people who do a study of the CPI think we're overstating by one to one and a half points," said Donald Ratajczak, director of the economic forecasting center at Georgia State University.
Federal Reserve officials are coming around to the same conclusion. An internal working paper written by three Fed staffers and published last April concludes that the index may be off around 1 percentage point, or about midway in a possible error range between zero and 1.8%
The paper, called "Working Paper Series No. 125," was written by David E. Lebow, John M. Roberts, and David J. Stockton, all economists in the division of research and statistics.
In a recent interview, Federal Reserve Board Governor Susan Phillips suggested the index could be off as much as two percentage points, which would put the actual annual change in price levels to a barely noticeable 1%. And, she said, Fed policymakers are interested in getting a better grasp on how much prices actually are changing.
"As long as inflation was either in the double digits or even above 5% or 6%, everybody could agree that the target had to be that we had to get inflation lower. Nobody worried about what we should be targeting, what we should be looking at, and how would we know when we get there," she said.
Phillips said she hopes "we're going to see much more discussion and what price series we should be looking at in trying to sense where we are with respect to inflation.
For years, Fed officials have looked at other price measures besides the consumer price index to track inflation and make forecasts about future prices. And President Bush this year revised the idea of the Fed and other central banks paying more attention to a global index of commodity prices, including gold, to set monetary policy.
The interesting point is that such measures point to an even more benign picture of inflation and, in some cases, show that the U.S. dollar buys more than it did 10 or 15 years ago.
The price of gold, one old-fashioned standby for measuring inflation, has been trading lately at around $340 per ounce after fetching $414 four years earlier.
The Journal of Commerce's index of industrial materials prices posted a reading of 99.80 in September, down from a reading of 106.00 three years earlier and identical to the 99.80 posted as long ago as March 1981. The index uses a base-year reading of 100 in 1980.
The Commodity Research Bureau's spot market index of all commodities, which uses a base-year reading of 100 for 1967, has been paddling harmlessly around 240 this year. That is comfortably below the readings in the range of 260 to 280 recorded in 1988.
In fact, say analysts, may businesses are finding that they cannot raise prices with ease the way they once did to fatten profit margins. Consumers and businesses are simply getting to be hard-nosed price watchers.
"I don't think that people are feeling inflationary pressures, and in fact, a number of folks in the business sector complain that they are not able to raise prices, so they in fact feel they have to cut prices," said Phillips.
Not all analysts are impressed with the fact that inflation is being pushed off the playing field. They say that much of the progress comes from a weak economy and a poor jobs market that has kept a damper on wages over the last several years. They also warn that large federal budget deficits in coming years could roil the bond markets and send interest rates higher.
"There's nothing new at all," said Roger Brinner, chief economist for DRI/McGraw-Hill, the forecasting firm in Lexington, Mass. "Inflation has gotten down low, but it's gotten low for very traditional reasons. We've been running with an awful lot of slack in this economy."
He added," The Federal Reserve is trying to talk the bond market. into being more upbeat, but the bond market really says, ~We haven't told you that we're sure inflation is going to be back. We have told you that with the federal deficit as big as it is, we're sure that there either will be inflation or real credit scarcity till the next millenium.'"
Other analysts are more optimistic.
"We're seeing evidence that the ability of producers to hike prices has been preempted to a major degree and that we're seeing a secular downturn in inflation," said William Sullivan, director of money market research for Dean Witter Reynolds Inc.
"I don't know whether we've driven inflation completely out of the household decision-making process or the corporate decision-making process, but we're as close to that as we've been in literally decades."
