Fear Not

How fundamental changes in the economy make inflation in the near future highly unlikely.
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The Federal Reserve may worry about inflation, but there's no reason for you to give it a second thought. Fundamental changes in the economy make inflation in the foreseeable future highly unlikely

Here's what happened on the macroeconomic front this spring:

The Federal Reserve Board was nervous about inflation, so it bumped interest rates up. Wall Street got skittish and drove down the bond market, sending stocks tumbling as well. Bill Clinton chastised the Fed for being too quick on the interest-rate trigger. The Wall Street Journal scolded it for being too slow.

If the economy keeps expanding, we'll see more of these moves and countermoves in the coming months. We'll also hear the usual cacophony of voices arguing over whether that ol' devil inflation is lurking just around the corner.

For company owners, the prospect of inflation can be seductive as well as scary. Inflation, after all, lets you borrow money now and pay it back later with cheaper dollars. It lets you hand out generous wage or salary hikes, and then cover them up with price increases. If you're clever, it lets you boost your margins every year. You just raise prices a little more than your costs are going up, and then tell customers it's "because of the economy."

But if you're hearing that siren song, plug your ears -- because the truth of the matter is that sustained inflation simply isn't on the horizon. Barring the unforeseeable, businesses can count on generally stable prices for the next several years. Smart ones will plan accordingly.

I make this statement not because I have unbounded confidence in the Fed but because the business world has changed in fundamental ways over the past few decades. And today's new economy just doesn't allow inflation to take root.

One source of rising prices, for example, is an economy that's straining at its capacity.

In that happy situation, factories are maxed out. Jobs are plentiful; growth is strong. Prices and wages are forced up across the board by the law of supply and demand. That's the kind of inflation we got in the late 1960s, when Lyndon Johnson added Vietnam spending to an already-booming economy.

But strained-capacity inflation isn't a clear and present danger today. Millions of workers are unemployed. Plenty of companies can boost production before they have to build new facilities. (Think of all those idle defense plants.) Granted, spot shortages and bottlenecks may lead to temporary price hikes in some industries. But today's economy is global, not national. In a global economy, shortages aren't likely to last long.

During the 1970s we became acquainted with a different sort of demon. We called it stagflation.

In those miserable days, unemployment stayed high and economic growth low -- yet prices somehow kept rising, year after year. Economists began muttering about "inflationary expectations" and the like. They were right: people did come to expect inflation, which led them to go on a credit binge.

But what gave inflationary expectations their bite was the fact that so many companies (and not a few workers) could control the prices buyers had to pay for their goods or services. When you can control prices, you tend to control them in only one direction. Up.

The biggest price controller, of course, was the Organization of Petroleum Exporting Countries (OPEC). Exxon and its pals went on a merry ride as OPEC ratcheted oil and gas prices upward. High energy prices, in turn, drove up everyone else's costs.

But a lot of other giant corporations could also raise prices with impunity, simply because they faced so little effective competition. Indeed, the various Big Threes and Big Fours and Big Twos in American industry typically formed cozy little clubs, with one company acting as price leader and the others following dutifully behind. In 1980 General Motors announced a price increase of 2.2%. Within seven days Ford and Chrysler had announced increases of their own: 2.2%.

Then too, many industries were still regulated during the 1970s. The list included trucking, railroads, the airlines, telecommunications, and financial services. Regulatory agencies, generally cooperative, granted regular price increases. (Hey, weren't costs going up?) As for labor, big unions still exercised effective control over wage levels. From 1972 to 1982, steelworkers' cash wages rose 179% and their fringe benefits 344%, both way ahead of inflation. Twenty years ago about a quarter of U.S. workers belonged to a union.

But to a time traveler from, say, 20 years ago, today's business world would be almost unrecognizable. Consider the differences:

OPEC is a joke, at least when it comes to controlling prices. The price of a gallon of gasoline, corrected for inflation, is as low now as it was in 1972.

Deregulation has opened up more and more of the economy to competitive pressures. Even local phone companies can't mindlessly raise rates these days, monopolies though they are. They're too nervous about cable operators or the long-distance folks entering their market.

Union membership -- and union influence -- has plummeted. Unions today represent only a little more than one-tenth of the private-sector work force. Strike activity focuses as often on preventing "take-aways" as on securing new wage gains.

Conceivably, political changes could reverse all three trends, though I'm not counting on any one of them being reversed, let alone all three. What can't be undone are the two other phenomena that have undermined corporate market power. One is global competition. Detroit no longer has the pricing latitude it once did because now Toyota, Hyundai, and others are in the game -- and they won't play by the same rules. The other is the rapid pace of technological change. IBM lost control over the price of computers because newer, smaller computer makers could offer more power for less money. The TV networks can't charge what they like for ads because too many advertisers will defect to cable.

To be sure, some industries periodically get a little price freedom. The auto companies can boost sticker prices this year because the high yen makes Japanese imports more expensive. But most companies rarely have much latitude. If they raise prices, some upstart with new technology or a different set of costs is likely to undercut them.

There is one inflationary wild card, and that's health care. Since 1982 the price of medical services has risen more than twice as much as the rest of the consumer price index has. It's still rising now, albeit not as fast as before. Congress may or may not come up with a health plan that effectively controls costs. If it doesn't, medical prices will continue to spiral upward.

Everywhere else, though, the message is the same: don't fear -- and don't count on -- a period of continually rising prices. Inflation of the persistent, sticky variety, the kind we grew to know and hate during the decade of long hair and bell-bottoms, is gone. Whatever the Fed may worry about, you just can't have that kind of inflation unless a lot of prices are under someone's effective control. Today they aren't.

* * *

John Case is a senior writer at Inc. and the author of Understanding Inflation (William Morrow, 1981).

Last updated: Jun 1, 1994




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