South-Western College Publishing - Economics  
Has Inflation Turned the Corner?
Topic Employment, Unemployment, and Inflation
Key Words Inflation, Costs, and Wages
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Reference ID: A163412998

News Story The Labor Department reported recently that inflation decelerated in April. Inflation is a period of general and sustained increases in the price level. A key word here is level. During a period of inflation some prices are going up and others are going down, but in general or on average, prices are rising. The current inflation report showed that the overall measure of consumer prices rose 0.4 percent in April after rising 0.6 percent in March and is setting at 2.6 percent annually.

The Labor Department conducts monthly surveys on prices for everything from cars to groceries and the latest survey indicated that average prices were beginning to fall. At the same time, wage gains were weak for most working Americans, consistent with an economy in the midst of a slowdown.

There is a risk that higher energy prices could be passed on to consumers through higher prices but in a slowing economy the risk is not that great. Wages have not kept up with inflation so family incomes are down which dampens demand. Although businesses would like to pass cost increases on to consumers they can’t for fear of losing sales.

“On the one side you’ve got cost pressures, and on the other side you’ve got consumers who are losing real income,: said Kevin Logan, senior market economist at Dresdner Kleinwort in New York. “You might want to raise your prices, but you can’t if people aren’t willing to pay.”

An adjusted price index, the core price index, excludes volatile food and energy prices from the computation. This index climbed only 0.2 percent in April after rising only 0.1 percent in March. This produces an annual core rate of 2.3 percent and represents the slowest annual pace in a year.

The report is in line with what the Federal Reserve has been predicting and it shows that inflation is moving toward a level that the central bank considers to be satisfactory. Fed chairman, Ben Bernanke publicly states the acceptable rate of inflation is between 1 and 2 percent, but always warns against any knee jerk reaction to sudden shocks like a rise in energy prices.

“It’s not quite low enough to fully satisfy the Fed,” said Stuart G. Hoffman, chief economist for the PNC Financial Services Group. “It’s a very slow process, but it appears the glacier is moving in the direction the Fed wants. This number, frankly, should make them a little less concerned.”

Some analysts view the report as a sign that inflation has finally turned the corner. April was the third consecutive month that the come rate did not increase compared to a year earlier. “We’re down to 2.3 percent,” Mr. Hoffman said. “I think that’s pretty convincing evidence that the worst of inflation is behind us.”

Discussion Questions:
1. Explain the statement by Mr. Logan that costs might lead to higher prices.
2. Discuss why the Fed prefers the core rate of inflation as opposed to the overall rate.
Multiple Choice/True False Questions:
1. The measure of core inflation excludes:
  1. housing and energy prices.
  2. energy and durable goods prices.
  3. housing and food prices.
  4. food and energy prices.
2. The Fed defines an acceptable rate of core inflation as between:
  1. 1 and 2 percent.
  2. 2 and 3 percent.
  3. 3 and 4 percent.
  4. 4 and 5 percent.
Source Jeremy Peters, “Inflation and Wages Show Slower Growth”, The New York Times Online, May 16, 2007.
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