South-Western College Publishing - Economics  
Money, Money everywhere—But it Doesn’t Go As Far
Topic Output, Income, and the Price Level
Key Words Personal Income, Inflation, and Monetary Policy
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Reference ID: A146284955
News Story

The U.S. Commerce Department reported that consumer spending rose at a seasonally adjusted annual rate of 0.6 percent in March; personal income moved up at roughly the same pace. Seasonal movements are defined as fluctuations caused by regular annual events, such as retail sales associated with Christmas and Easter A seasonally adjusted statistic is one from which seasonal movements have been eliminated, making the data comparable from month to month.

On the inflation side prices rose 2.1 percent over last April, excluding food and energy prices. Any number below 2 percent is considered “healthy” by Federal Reserve officials when they deliberate on monetary policy, so the current figure is slightly above what they would like to see. Add in steeply rising energy prices, and the Fed may feel that inflation is on the rise.

The University of Michigan’s consumer sentiment index, an indicator of how well the economy is expected to perform in the next two or three months, dropped to 79.1 in May from 87.4 in April. Many economists have predicted this trend for the remainder of the year. “A gradually softening trend for consumer spending is the most likely scenario in the quarters ahead,” Joshua Shapiro, chief United States economist at MFR, wrote in a research note, “particularly as housing cools off. The recent steep rise in gasoline prices will not help any as well.”

Richard Curtin, director of the Michigan index agrees. “Consumers expect a slowdown in economic growth. High gas prices and rising interest rates have finally convinced households to sharply realign their expectations.” This scenario of slower spending and rising prices causes a dilemma for Fed policy makers. They want to ward off inflation, but do not want to stymie economic growth. When they decide what to do about the discount and suggested Federal Funds rate later this month, the Fed will have to look at the inflation numbers against the backdrop of what, by most accounts, is a slowing economy.

“The economy is slowing down,” said Stuart Hoffman, chief economist with PNC Financial. “But at the same time inflation is speeding up. That’s why they have a tough call to make. Is rising inflation a bigger threat to sustained economic growth, or is a softer economy a bigger threat?”

Questions
1.

What is meant by the term “seasonally adjusted” data?

2. Discuss the dilemma posed to the Fed policy makers why economic growth is slowing and inflation is rising.
Source Jeremy W. Peters, “Income Rises but So Does Inflation”, The New York Times Online, May 27, 2006.
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