Slow Economy, High Prices Raise Specter of Stagflation
By Neil Irwin and Dina ElBoghdady
Washington Post Staff Writers
Wednesday, February 27, 2008; D01
Prices for a wide variety of the materials that businesses buy soared in January, according to a government report, creating new pressure for businesses to raise the prices they charge consumers.
The producer price index, which measures wholesale inflation, rose 1 percent in January -- more than double what economists had forecast. Wholesale prices are up 7.4 percent over the past year, the Labor Department reported, their steepest rise since 1981.
Fuel prices were a major driver of the January increase, but prices also rose rapidly for a broad range of other items that businesses buy: agricultural machinery (up 2 percent from December); transformers and power regulators (3.6 percent); flour (3.3 percent); industrial chemicals (2.4 percent); and nonferrous wire and cable (3.8 percent).
Businesses tend to pass on the increased costs of their wholesale purchases to consumers. Last week, the Labor Department said that consumer prices rose 4.3 percent in the year ended in January.
Together, the two indexes indicate that the rapid price escalation on world commodity markets last year, especially for oil and grains, are rippling through to what both consumers and businesses must pay for an entire shopping cart's worth of merchandise.
Also, the slumping value of the dollar on world currency markets is making imports more expensive. Yesterday, on weak economic news, the dollar fell to an all-time low relative to the euro. A euro cost $1.498, which could eventually make German cars and French wine more expensive for U.S. consumers.
"It's very clear that inflationary momentum not only has not yet ebbed, it's still building," said Kenneth Beauchemin, U.S. economist at consulting firm Global Insight.
There was also evidence yesterday that the economy is slowing. Consumer confidence fell to its lowest level since the beginning of the Iraq war, the Conference Board reported. And home prices nationally fell 8.9 percent in the fourth quarter compared to a year earlier, according to the S&P/Case-Schiller index. Prices fell 9.4 percent in the Washington region.
The national decline was the steepest since economists Karl E. Case and Robert J. Shiller started tracking prices in 1987. The index measures repeat sales of existing single-family homes in the nine divisions defined by the Census Bureau.
As the economy slows and inflation rises, fears are rising that the United States could be facing a period of stagflation, the crippling mix of high inflation and a stagnant economy that was present in the 1970s.
"We're in stagflation, and it's going to get worse," said Peter Schiff, president of Euro Pacific Capital.
Inflation remains well below the double-digit levels of the 1970s, however, as does unemployment, which was 4.9 percent in January.
Nonetheless, rising prices put the Federal Reserve in a bind. It has launched an aggressive interest rate cutting campaign to try to keep the downturn in the economy from becoming a severe, prolonged recession.
But those steps to spur the economy could make it harder for the central bank to fight inflation, particularly if ordinary businesses and individuals come to expect that high prices in the past year will become the normal state of things.
For now, leaders of the central bank appear more inclined to keep cutting rates to ease the downturn in the economy than to reverse course.
"I do not expect the recent elevated inflation rates to persist," Donald L. Kohn, vice chairman of the Fed, said in a speech yesterday. "The adverse dynamics of the financial markets and the economy have presented the greater threat to economic welfare in the United States."
Kohn's expectation that inflation will moderate is based on an assumption that commodity prices will level off, and that the slower economy will reduce upward pressure on wages.
He and other leaders of the Fed have taken solace in data and surveys that suggest Americans do not expect inflation to remain high. "Inflation expectations remain reasonably well anchored," Kohn said yesterday.
Chairman Ben S. Bernanke is to testify on Capitol Hill today and Thursday, and will likely express similar ideas, as he did in congressional testimony two weeks ago.
But others in the Federal Reserve system appear to be more worried, and as a result, less inclined to continue the rate cutting campaign.
"It's not enough in my opinion, to assume that if we slow down domestically here that that will give us the relief that we would like to have . . . on the inflationary front," Richard W. Fisher, president of the Federal Reserve Bank of Dallas, said on PBS's "Nightly Business Report" yesterday. Fisher dissented from the Fed's decision to cut interest rates by half a percentage point on Jan. 31.