Fed, Main Street Have Differing Views on Inflation

Thursday, 10 Feb 2011 10:20 AM

 

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Inflation in the United States? The Fed might not see it, but company executives, especially those who sell to consumers, say if it is not here yet, it is on its way.

In congressional testimony on Wednesday, Federal Reserve Chairman Ben Bernanke said "overall inflation is still quite low and longer-term inflation expectations have remained stable."

That may come as a surprise to anybody who is planning to buy a tank of gasoline, Starbucks coffee, a McDonald's hamburger or a Whirlpool washing machine.

"There definitely seems to be a disconnect with the Fed's commentary and the experience of the common man," said Lawrence Creatura, a portfolio manager with Federated Investors.

"Price increases are getting through and you really only have to go through a fast-food drive or the supermarket to observe that."

Corporate executives, faced with rising costs for beef, cotton, copper and a host of other commodities have repeatedly spoken in recent weeks of plans to raise prices to at least recover some of those costs.

McDonald's said it expected costs to rise 2 percent to 2.5 percent this year in the United States and 3.5 percent to 4.5 percent in Europe.

Chief Financial Officer Pete Bensen said McDonald's would "raise prices where it makes sense" to offset those rising costs.

Appliance maker Whirlpool and rival Electrolux also said they would raise prices this year, with Electrolux pegging its increase at 8 percent to 10 percent in North America, starting in April.

Late last year, Starbucks raised drink prices in the United States and China because of surging prices for coffee and other commodities.

And on Wednesday, Polo Ralph Lauren Corp said it would raise more in the second half of this year, with Chief Operating Officer Roger Farah saying the company had the brand equity to allow it to pass on rising costs for cotton, cashmere and wool.

BACK TO 2008

Commodity prices, as measured by the Reuters-Jefferies CRB index, are up 27.5 percent since the end of June and at their highest since the economic meltdown in 2008, as supplies of copper, heat and other goods are stretched by demand from emerging markets grows.

So why the disconnect between consumers and executives and the Fed?

It is because the Fed's top officials, including Bernanke, look at the economy through a prism that compares how fast the economy would grow if firing on all cylinders versus its pace when sputtering.

Seen that way, there is a wide gap between the current state of the economy and its potential, as measured by the job market. About 8 million jobs were lost during the recession and about 13.9 million Americans are unemployed.

The jobless rate, at 9 percent, is well above the 5 percent to 6 percent level most policy-makers consider full employment. The San Francisco Fed published a paper this week saying that even if employers add a robust 239,000 jobs a month, it will be well into 2013 before jobs lost during the recession are recovered.

Also, the Fed likes to see inflation in the range of 2 percent or a bit below. Until recently, inflation had fallen to the point where policymakers worried about the risk of an outright downward deflationary spiral.

The Fed's preferred measure of inflation, the personal consumption expenditures index, rose a modest 1.2 percent in the 12 months to December, the most recent data shows. Core inflation, which strips out food and energy costs and which the Fed believes is a better indicator of where inflation is heading, has been near five-decade lows.

While there is some belief inflation has hit bottom and is rising again, many Fed officials do not think commodity prices gains will contribute to a problematic spike.

"We have recently seen significant increases in some highly visible prices, notably for gasoline," Bernanke said last week. "Indeed, prices of many commodities have risen lately, largely as a result of the very strong demand from fast-growing emerging market economies, coupled, in some cases, with constraints on supply. Nevertheless, overall inflation remains quite low."

Policymakers are also confident inflation is not brewing. Bernanke told skeptical members of Congress on Wednesday that measurements of where financial market expects inflation to be in the future are well contained.

"There is not really any indication in our financial markets that in the United States there is an expectation of inflation," he said.

However, there are analysts who think the Fed overestimates how much slack there is in the economy. The normal growth rate for the United States, with its aging population, may be slower than the Fed believes, and the natural rate of unemployment may be higher, they say.

"That means there's a smaller output gap and therefore less downward pressure on inflation, and if you look out a couple of years, more inflation risks from very easy monetary policy." said Barclays Capital's Dean Maki.

"We would agree with the Fed that we're not likely to see a sharp upturn in inflation soon, but we do see more medium-term risks with the current policies than the Fed likely does," he said.

But for consumers, the upturn is here now, analysts said.

"It varies by product, but it is significant enough to be observable, especially if you are on a fixed budget," Federated's Creatura said.

© 2014 Thomson/Reuters. All rights reserved.

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