|The Wall Street Journal Interactive Edition
-- December 16, 1996
The Outlook: Inflation Stays Low, with Aid of Some Luck
In forecasting the economy and Federal Reserve policy, analysts face a tough question: How much longer will inflation remain docile if the unemployment rate stays near its current, relatively low level?
In the 1970s, a simultaneous increase in unemployment and inflation shattered the conventional wisdom that wages and prices rise predictably when unemployment falls. But now, 20 years later, this simple concept has been rehabilitated as a guide to the economy's short-term ups and downs. The 1970s paradox is being blamed on the oil-price surge, a shock that caused the U.S. to suffer more inflation than expected at any given jobless rate.
Today, conventional wisdom is again under assault. Until recently, many economists were certain the low jobless rate would produce a spate of wage and price increases. If workers are scarce, the logic went, wages rise. And when wages rise, prices follow.
When unemployment fell to 5 1/2% in late 1994, inflation-phobes said: "Just wait." We're still waiting. The rate remains below 5 1/2%, yet wages are inching up only slowly and, by some measures, price inflation is abating.
Now comes Robert Gordon of Northwestern University with an appealing explanation. If oil prices were "an adverse supply shock," he says, we are seeing the opposite today. Call it a "positive supply shock" that allows the U.S. to enjoy less unemployment without the predicted price increases. "We've had this gift big enough to pull down inflation by almost a full percentage point just when we needed the help to avoid accelerating inflation," Mr. Gordon says.
What is this beneficent force? The marked slowing of health-care prices and the rapid decline in computer prices. Taken together, medical services and business purchases of computers and communications gear account for more than $1 trillion of the nation's $7.6 trillion annual output of goods and services.
By Commerce Department measures, businesses are paying 48.6% less for computer power than they did five years ago. During the past 12 months alone, the price has dropped 15%. A quick glance at personal-computer ads shows how much more computer muscle $2,000 buys each year. That is a big deal, because computer and communications hardware account for $1 of every $4 of business investment spending. Five years ago, it accounted for $1 in $5.
Simultaneously, the rate of price increases charged by doctors, hospitals and nursing homes has decelerated. At the end of the 1980s, the best Commerce Department measures say prices of medical services were rising about 8% a year. During the past year, they have risen only 2%.
Without the good news on health and computer prices, inflation would be significantly worse. "It's the inverse of what happened in the 1970s, though not as much and not accompanied by an extraordinary event like OPEC," says Bradford DeLong, an economic historian at the University of California at Berkeley.
By this logic, Fed Chairman Alan Greenspan isn't so much skillful or omniscient as lucky. And it isn't President Clinton's policies but his good fortune that explains the economy's sterling performance. "It's manna from heaven," Mr. Gordon says.
There is another explanation for the surprisingly small increase in wages: Workers are so traumatized by downsizing, outsourcing, layoffs and the waning power of unions that they aren't demanding raises. "Capitalism is getting meaner," suggests Princeton University economist Alan Blinder. He finds this explanation more compelling than Mr. Gordon's.
Businesses do seem to be operating differently. With competition stiff, executives can't be sure price increases will stick, so they are more reluctant than usual to raise wages. When shortages of entry-level workers and a higher minimum wage push up wages for some, employers may be stingier with raises for others. Employers may be pocketing health-care savings instead of passing them along to workers. Popular pay-for-performance plans reward only workers whose productivity is improving. And when given a choice, workers prefer job security to bigger paychecks.
Chances are that more than one factor explains the quiescence of inflation. Workers are cowed, and that is restraining wages. But the unusual behavior of health-care and computer prices also helps hold down inflation.
If the economy and corporate profits remain strong, workers eventually will demand bigger raises. "At some point," Mr. Greenspan warned last summer, "greater job security will no longer be worth the further sacrifice of gains in wages." But even if that occurs, Mr. Gordon's "manna from heaven" may keep inflation quiet a while longer and allow the Fed to tolerate a refreshingly low jobless rate.