South-Western College Publishing - Economics  
Inflation Slows in April
Subject Price Index
Topic Employment, Unemployment, and Inflation
Key Words

Inflation, Price Index, and Economic Growth

News Story

Although prices rose in April, they rose at a slower rate than in previous months. Higher energy prices helped push the April Consumer Price Index (CPI) up 0.5 percent after a March increase of 0.6 percent. The result is an overall inflation rate of 3.5 percent over the last 12 months--the fastest inflation rate increase since November.

While the overall index rose, the core price index--which does not include the volatile contributions of food and energy prices--did not move in April. This helped soothe concerns that increasing energy prices--which hit record highs in March--was creating an inflationary trend throughout the economy.

"Obviously it's very good news," said Jack Ablin, chief investment officer of Harris Private Bank in Chicago. "It still keeps us inside the "Goldilocks" band, where economic growth is warm enough and inflation is cool enough that the Fed can continue raising interest rates at a measured pace and keep things under control."

The March upsurge in consumer prices suggested that energy prices might generate more broad-based inflation, as businesses passed their rising energy costs on to consumers. Then a first-quarter 2005 unexpected slowdown in economic growth numbers hinted that the economy was losing steam.

"When the Fed met on May 3, inflation and growth looked imperiled; that would have left the Fed uneasy on both its goals," said Princeton economist, former Fed Vice-Chairman and famed textbook author Alan S. Blinder. "I think the Fed is feeling much more comfortable today."

Robert Gay, a former economist at the Federal Reserve and current managing partner at New York investment advisory firm Fenwick Advisers, says that oil prices have receded from their peaks. This should reduce inflation in coming months. "There is a good chance next month the Consumer Price Index is going to be a negative number," said Mr. Gay. "This [a negative CPI number] will relieve concerns over the pass-through of higher oil prices."

Additionally, the dollar appears to have hit a bottom in international currency markets, indicating less imported inflation. "This is a normal midcycle phenomenon, where growth is not at its boom-time highs and inflation is not at its post-recession lows," said Richard B. Hoey, chief economist at the Dreyfus Corporation. "In fact," Mr. Hoey said, "the rise of 2.2 percent in core consumer prices over the last 12 months…..is pretty close to where the Fed hoped we would be."

The question now: How far will future prices rise? Producer prices have also risen, indicating that inflation is building even at early production stages-at the raw materials level. The Fed, however, has made it clear that it wants to keep raising interest rates at a measured pace in the months ahead. Barring any unexpected downturns in the economy, this measure should keep inflation under control.

Questions
1.

What type of inflation is occurring when businesses pass on their higher costs to consumers?

2. Explain the relationship between higher interest rates and inflation.
3. Define and discuss the phenomenon of imported inflation.
Source Edmund Andrews, "Price Report Eases Fear of Inflation," The New York Times Online, May 19, 2005.

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