- The Washington Times - Sunday, January 18, 2004

A host of year-end output and pricing data has been released recently, essentially confirming that the economic expansion has indeed accelerated with little evidence of inflationary pressures.

Industrial production increased by 2.3 percent during 2003 after rising by 1.4 percent during 2002, the Federal Reserve reported Friday. While December’s output increase was a relatively mild 0.1 percent, much stronger advances in October and November brought the fourth quarter’s annual rate of increase in industrial output to an impressive 6.2 percent. That represented a marked acceleration of industrial output from the 3.8 percent annual rate that prevailed in the third quarter, when the overall economy expanded at a robust annual rate of 8.2 percent. The Fed also reported that the manufacturing sector grew at an annual rate of 6.6 percent during the fourth quarter, nearly 3 percentage points higher than the rate during the third quarter. During all of 2003, manufacturing increased by 2.9 percent, more than 2 percentage points higher than 2002’s growth rate.

December pricing data revealed that inflation, measured by the overall consumer price index, increased by 1.9 percent during 2003, half a percentage point lower than 2002’s rate. More importantly, the core consumer price index, which excludes the volatile food and energy sectors, increased by only 1.1 percent last year. That was the lowest core consumer inflation rate in 40 years; and it represented continuing sharp deceleration from 2002 (1.9 percent) and 2001 (2.7 percent). Core inflation at the wholesale level, measured by the producer price index for finished goods less food and energy, remains equally subdued, having increased by 1 percent in 2003 after declining by 0.5 percent during 2002.

Moreover, understandable fears that the dollar’s significant depreciation since early 2002 would translate into major inflationary pressures from imports have not been realized. Since February 2002, the dollar has declined in value by more than 25 percent against the world’s major currencies and by nearly 15 percent against a weighted index that includes the currencies of all of America’s trading partners. Nevertheless, the price index of non-petroleum imports increased by only 0.3 percent during 2002 and by 1 percent last year. So far, foreign producers have elected to absorb the rising costs reflected by the dollar’s decline rather than increase their prices at the expense of losing share in the world’s largest consumer market.

With foreign suppliers to the U.S. market declining to pass on their increased costs in the form of price increases, their U.S.-based competitors continue to operate with little pricing power. Meanwhile, high levels of unused production capacity throughout both the United States and the world continue to exert strong pressures against price increases, particularly in the markets for durable goods such as autos, appliances and other long-lasting products. In the United States alone, for example, the capacity utilization rate for total industry was less than 75 percent in 2003, its lowest level in 20 years. The capacity utilization rate of the manufacturing sector fell to 73.4 percent last year, the sixth consecutive year it has declined.

Despite the continued prevalence of excess capacity and declining core consumer inflation, the Fed has ratcheted down its publicly expressed fears of deflation. Nevertheless, it seems clear that the economy continues to face intense, underlying disinflationary pressures that could tip into the debilitating deflationary zone if the economy were to suffer a major shock. This is all the more reason for the Fed to continue its accommodative monetary policy and for fiscal policy to remain expansionary. The expansion simply cannot be allowed to peter out.

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