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Inflation not likely to make a comeback
Slow and Low

Anyone old enough to remember the "misery index," knows inflation used to be a hot topic in America--and that it hasn't been for some time.

Despite the inevitable ups and downs of the national and state economies, Texans have enjoyed nearly a quarter-century of low inflation.

The inflation that plagued America in the 1970s and early 1980s was driven largely by volatile energy prices, and recent jumps in oil prices have prompted some to wonder if the scenario will repeat. But continuing economic strength and global competition in the production of goods and services are likely to keep the inflation threat tamed, according to Ellen Beeson Zentner, assistant vice-president and economist for the Bank of Tokyo-Mitsubishi UFJ in New York.

Measuring inflation
To assess the effects of inflation on consumers, economists generally rely on the Consumer Price Index (CPI), a measure maintained and reported by the U.S. Department of Labor's Bureau of Labor Statistics (BLS). The CPI provides monthly data on the average price of a large "basket" of goods and services commonly purchased by consumers, from fruits and vegetables to gasoline and airline fares.

"They literally go out into the marketplace, say to your neighborhood grocery store, and look at a particular type of cheese, for instance," said Zentner. "They monitor the price of that particular type of cheese from month to month and [note] how that price changes. All of these products are weighted and then compiled into an index."

The CPI reports these changes as an index number, based on a reference value of 100 for the period 1982-84. The March 2006 CPI of 199.8, then, indicates that the aggregate price of the CPI "basket" has nearly doubled since 1982-84.

The Fed steers
The Federal Reserve watches the CPI and other indicators closely as part of its ongoing attempt to contain inflation, using its control of short-term interest rates to steer the economy. Lower rates tend to stimulate economic activity by lowering the cost of borrowing, while higher rates have the opposite effect.

"At the moment, we're at the high end of the Fed's comfort level, and that's why the Federal Reserve has been raising short-term interest rates," Zentner said. "That's their way of slowing the economy so that it slows inflation."

The Feds can't overcome some economic conditions. The spike in oil prices during the 1970s spurred the nation's last sustained period of high inflation. Unprecedented price increases followed both the 1973 Arab oil embargo and the 1979 Iranian hostage crisis.

"Since then we have become much less dependent on oil," Zentner said. "That was a wake-up call."

Low, low prices
The biggest factor containing inflation has been the growth of global competition in the manufacture of many common goods, according to Zentner.

"As much as we like to complain about the number or products that we import from China and other countries, and how many jobs we export, it's [their] growth that has helped keep prices suppressed," said Zentner.

"It's all made very inexpensively and exported to the United States, where we get to enjoy a much lower price than if it were produced locally. By and large, we can thank China and other Pacific Rim countries for keeping our prices low."

Americans have benefited. The nation hasn't endured double-digit inflation since 1981.

"We've never had that since [1981]," said Gary Preuss, an economic analyst for the Comptroller's office. "Since 1992, we've been around 2 or 3 percent."

And even the recent rise in oil prices has had little effect.

"[Inflation] has been moving slightly upward in the last year or two because of the rise in energy prices," Preuss said. "Right now we're running about 3.4 percent, year to year."

Pricing power
Competition also slows inflation by discouraging producers of goods and services from raising their prices in response to their own increased production costs. Economists call the ability to pass on costs to customers "pricing power."

"Because of global competition, a lot of producers don't have pricing power, and so they've been simply eating the additional cost and not passing it on to consumers," said Zentner. "Competition doesn't allow them to, when anyone else can step in and simply provide that product for less."

Fortunately, the continuing strength of the U.S. economy has helped many businesses manage costs without increasing their prices.

"Our economy has been growing at a very robust pace since at least mid-2003," Zentner said. "Businesses are sitting on record amounts of cash. That has allowed them a cushion against higher costs."

What about tomorrow?
At present, indications are that the patterns that have constrained inflation for the last two decades will continue.

"The Comptroller's state economic forecast [for inflation] is really fairly low out to 2030," said Preuss.

Zentner agreed, but sounded a warning.

"We don't expect rampant inflation, even given high and sustained oil prices," she said. "We haven't had a scenario like the '70s, when we were simply cut off from a major oil supply source. But that's not to say that if [a similar situation arose] we wouldn't get oil prices doubling and throwing the economy into recession."

Still, the current outlook is positive.

"The U.S. economy has a lot of momentum right now," Zentner said. "It would take something very volatile and unexpected to throw this economy off."

Bruce Wright