- The Washington Times - Tuesday, February 25, 2003

The Labor Department last week released its estimates of inflation in January at both the producer and the consumer levels, sending seemingly conflicting signals. On Thursday, the Bureau of Labor Statistics (BLS) reported that the producer price index (PPI) for finished goods, which measures price changes at the wholesale level, increased by a whopping 1.6 percent in January. The next day the BLS reported that prices paid by consumers rose a far more modest 0.3 percent last month. The consensus among economists is that there is little short-term danger of a major dose of inflation. That's the good news.

The bad news can be gleaned from a familiar economic chain reaction. For whatever reason (the 1973 Arab oil embargo, the 1979 Iranian revolution, Iraq's 1990 invasion of Kuwait, OPEC's resuscitation in the late 1990s), world crude oil prices soar. Then, if their impact becomes deeply rooted throughout the consumer sector by causing the prices of non-energy goods to rise, the Federal Reserve reacts by raising interest rates to reduce inflationary pressures, precipitating a recession in the process. Thus, the cause of the past five recessions (1974-75, 1980, 1981-82, 1990-91, 2001) can be directly attributed to soaring oil prices. (Technically, the 1990-91 recession began the month before Iraq invaded Kuwait, but it has been argued that the recession would not have occurred without the soaring oil prices following the invasion.)

The causes of the PPI's hefty 1.6 percent January jump included: a 4.8 percent increase in energy prices; a roughly 4 percent rise in auto prices following November-December reductions; and a jump in food prices.

Additional perspective comes from the fact that, while the PPI has increased by 2.8 percent over its January 2002 level, most of that increase resulted from a 17 percent rise in energy prices. Meanwhile, the consumer price index's core index increased a very modest 0.1 percent in January, the third such rise in the past four months. For the past 12 months, the CPI's core increased by less than 2 percent.

Outside of the energy sector, firms continue to lack any pricing power at the retail level. This leads most economists to believe that energy-induced inflationary pressures will be kept in check for the foreseeable future. But the result will likely be a major hit against already-meager profits. That could adversely affect business investment spending, which has been sputtering for more than two years. If consumers retrench, a recession could ensue. That's the really bad news.

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