When is the inflation coming? The economy is growing at a rate
that in the past would have caused much anxiety on the part of the
Federal Reserve. Economic growth is over 4 percent for the past
year. Many economists, including Laurence H. Meyer, a governor of
the Federal Reserve, believe that this growth rate, given productivity
and labor force growth, should cause wages and prices to increase.
The data do not support this belief. Although wage costs are accelerating,
prices have not kept in step and profits are at healthy levels.
The Council of Economic Advisers and the Congressional Budget Office
have estimated the NAIRU, the non-accelerating rate of unemployment,
to be between 5.4 and 5.8 percent. When unemployment drops below
this rate, there is pressure on wages to increase. Cost-push inflation
theories then translate changes in wages to changes in prices. Each
year that the unemployment rate is below the NAIRU, about one-half
percent is added to inflation according to some estimates.
Some economists are questioning the Fedís decision to hold interest
rates constant in light of these pressures. There are some reasons
to hold the line. The economy might be on the verge of cooling itself
and therefore any downward pressure might turn a soft landing into
a recession. There is some fear that a significant hike in interest
rates might produce a major decline in the stock market. Other worries,
such as the impact of a decline in the U.S. economy on Asian financial
markets, are also reasons to avoid interest rate hikes.
Some increase in interest rates will likely come this year. The
evidence is that inflation is reversible and an increase in prices
could be reversed without a recession. The big uncertainty is the
reaction of the stock market.