WASHINGTON -- Weakness on the food-price inflation front, though not a cause for celebration at supermarkets, could help check overall inflation and head off future interest rate increases.
The Federal Reserve Board noted recently that ongoing declines in food prices should help slow inflation in 1997, barring any weather disasters.
According to the Fed's annual economic outlook, prices of farm products have dropped back from the highs of last summer, meaning that this year's rise in food prices at retail "should be considerably smaller than that of 1996."
Slowing price hikes at the checkout counter could help keep in check the Consumer Price Index, which measures inflation. It could also steady the hand of Federal Reserve policy-makers, who in late March raised the overnight interest rate a quarter of a %age point, to 5.5%.
The rise was the first in more than two years and sent stocks plummeting. Federal Reserve Board Chairman Alan Greenspan, in the weeks before that decision, had cautioned against "excessive" stock prices. Two days after the decision, as major banks followed the Fed's lead, the Dow Jones industrial average dropped 215 points.
Most economists had been expecting the central bank to raise interest rates before late spring or early summer, and now many expect the Fed to continue cranking up the overnight interest rate to 6%, the level that slowed the nation's strong growth in 1994.
Whatever the Fed governors decide, their approach has worked so far: The economy has grown for six years straight. According to the Commerce Department, the economy grew at a 2.4% rate in 1996, compared with 2% in 1995 and 3.5% in 1994. The core inflation rate -- CPI minus food and energy -- rose 2.6% in 1996 and 3% in 1995.
Looking into the future, most economists assume that the nation's economic growth will slow as consumer debt grows. Rapid capital spending of the past two years is expected to retreat, while the dollar remains strong and inventories increase.
According to the Economic Forecasting Center at Georgia State University, these arguments back a forecast of slower growth -- such as the Federal Reserve's prediction of 2% to 2.25%, or the more vague "we won't do as well in 1997" prediction of the U.S. Chamber of Commerce.
And yet, EFC director Donald Ratajczak writes in his forecast, "These same arguments were used prior to the [1996] fourth quarter, when economic growth was a surprising 4.7%." That figure was later revised to a still-robust 3.9%.
Nevertheless, the forecasting center expects history to repeat itself in 1997. The center's forecast predicts economic growth should exceed 3% for the next three quarters before running out of steam next fall.
Growth in the fourth quarter of 1997 should average 2.7% against the fourth quarter of 1996. Growth in the fourth quarter of '96 averaged 3.2% over that of 1995's fourth quarter. The center predicts that will fall to less than 2% in 1998.
Ratajczak added, however, that a tight labor market will most likely reduce profit growth and raise inflationary pressures. Meanwhile, inflation should rise from 2.9% in 1996 to 3.2% in 1997.
"These are not large gains in inflationary pressures, but they are expected to generate a response from the Federal Reserve by the early summer meeting," Ratajczak said. "Federal funds rates and the prime rate should rise by half a%age point late in the year, and then sustain those higher levels in 1998."
Testifying before the Senate Banking Committee in February, Greenspan cautioned that previous trends cannot be easily relied upon to chart the future.
"The processes have differed from cycle to cycle," Greenspan said. "And what may have been a useful leading indicator in one instance has given off misleading signals in another."
Yet Greenspan said that all Fed signs point to low inflation for 1997 -- between 2.75% and 3% for the year. He added that trends now appearing in the core CPI may turn less favorable as compared with recent years.
"A continued tight labor market, whose influence on costs would be augmented by the scheduled increase in the minimum wage later in the year+could put upward pressure on core inflation," Greenspan said. "Moreover, the effects of the sharp rise in the dollar over the last 18 months in pushing down import prices are likely to ebb over coming quarters."
Greenspan has said repeatedly that to control inflation, it is crucial for the Fed to act "ideally pre-emptively." Nevertheless, at the U.S. Chamber of Commerce, Deputy Chief Economist Robert Barr said neither trend should have enough power to move federal interest rates.
Barr noted, for example, that the producer price index, which measures inflation at the wholesale level, has held steady for almost nine months. And although the nation's job force has grown, salaries have remained fairly stable.
Despite such stability, however, Barr said the chamber's earlier predictions for 1997 have already been skewed by the higher-than-expected numbers from the fourth quarter.
The chamber has not yet refigured its original 2.3% projection for 1997's economic growth, but Barr said one thing is certain: "We don't think growth is sustainable at that rate." He added, "There is going to be a slowdown in growth+We'll have a strong first quarter, but we won't do as well in 1997."
