The full text on this page is automatically extracted from the file linked above and may contain errors and inconsistencies.
October 3, 1 980 What's headfor Prices? Most economists attribute inflation trends to past changes in money growth, but "shocks" of one type or another have also contributed recently to the price upsurge. Last year's neardoubling of OPEC oil prices and this year's drought-caused food shortages have created bulges in the price indexes atop a high underlying rate of inflation. Any analysis of the future direction of prices thus should consider the possibility of new shocks from such factors, as well as the underlying productivity and money-growth trends. first-half upsurge Vola.tility has marked price patterns in each of the first several quarters of 1 980. In the first quarter, the consumer price index (CPI) soared at almost a 17-percent annual rate, reflecting sharp increases in both energy and homeownership components. During that period, retail energy prices surged at a 53percent annual rate-more than double the preceding quarter's pace-as the huge crude-oil price increases posted by the OPEC cartel in late 1 979 and early 1 980 filtered through to the prices of energy purchased by consumers. The homeownership component also rose at an accelerated pace, under the influence of rising mortgageinterest rates. On the other hand, the increase in retail food prices decelerated during this period, reflecting declining producer prices for livestock, fruit, vegetables, poultry and eggs. u.s. The inflation rate-as measured bythe CPIimproved only modestly in the second quarter, as the index registered a 14-percent annual rate of increase. Most of the improvement emanated from the energy component, which rose at about the high fourth-quarter rate rather than the stratospheric first-quarter pace. The homeownership component again increased sharply, but food prices continued to rise moderately, in line with the first quarter's performance. Apparel and medical prices also contributed to the slight secondquarter deceleration. After the summer lull The early-summer period was quite different, with only a 5Y2-percent annual rate of CPI increase overthe June-August period. Butthis deceleration, marked by July's overall stability and August's single-digit inflation number, turned out to be something of a fluke. The major reason was a decline in mortgage rates, which partly offset a sharp acceleration in food prices. But the reported interest-rate declines of July and August actually represented commitments made during the late-spring downturn in interest rates. In view:ofthe midsummer turnaround in rates on new mortgage commitments, the housing component wi II aggravate rather than cush ion the u pward movement in the overall index this fall. Moreover, the recent upsurge in .food prices may be just the beginning of a major rise in that key component of the average household budget. Over the June-August period, the food component of the CPI rose at a 21 percent annual rate-more than three timesthe increase of the second quarter. That upsurge reflected drought-induced losses of livestock and poultry, as well as even sharper price increases for sugar, fruits and vegetables. More ominously, the CPl's future movement wi II be affected by JuIy and August's explosive 62-percent annual increase in producer prices of finished foods, and equally huge food-price increases at the crude and intermediate levels. The food component has a weight of nearly 18 percentin the overall consumer-price index. Assuming it rises at a 21 -percent annual rate over the third quarter as a whole, the acceleration in food prices between the second and third quarters could add as much as two percentage poi nts to the rate of increase in the overa II consumer price index. Energy was an important contributor (along with interest rates) to the recent price deceleration, but it poses a major question mark over the near-term future. The energy component and energy cou Id be expected to decelerate if the recession continues, reflecting a low rate of capacity utilization in manufacturing. Yet during the fourth quarter, the consumerinflation rate appears likely to move into double-digit territory again after the recent softness, due to the present accelerated rate of increase in food prices and homeownership costs. It may even approach the 1 4percent rate of the spring quarter. of the CPI rose atonly a 3-percent annual rate over the June-August period, compared with a 33-percent rate of increase in the preceding six-month period -reflecting a recessioncaused falloff in demand and consequently a massive buildup of oil inventories throughout the world. The Iran-Iraq conflict raises dark cloud over the energy outlook, but no one yet knows when (or if) the effects of that conflict will outweigh the effects of a worldwide oil glut. a After the recession The energy situation requires a closer 1001<. Some analysts believe the Middle East conflict will contribute to only a brief spurt in energy prices, with the resumption of a moderate price pace later this year. They maintain that spot prices for crude oi I and refi ned products will rise briefly, in such key markets as Rotterdam, due to the initial fear of possible shortages. That movement will provide support for the current structure of OPEC contract prices, including the recent $2-perbarrel increase posted by Saudi Arabia. But spot prices should stabilize thereafter as basic supply-demand factors come into play. Many analysts, on the basis of past cyclical productivity behavior, anticipate a weakening of price pn;ssures when the economy moves into the recovery period. The CPI rose at more than an 8V2-percent rate at the recession trough in the first quarter of 1 975, but five quarters later it rose at only a 3 V2-percent rate (see chart). A moderation of food and energy prices accounted for some of that deceleration, but the remainder of the index showed similar moderation, reflecting a strong improvement in unit labor costs. In the first quarter of 1976, private nonfarm output per worker-hour rose at a 7-percent annual rate, and compensation per hour at a 9percent rate. Consequently, unit labor costs rose at only a 2-percent annual rate in that period. This analysis reflects the fact that worldwide crude-oil inventories reached a monumental 6 billion barrels before the conflict. At that level, it wou Id take a prolonged cutoff of the 4 million barrels/day of Iranian-Iraqi exports to make a dent in the inventory. Moreover, that impact could be mitigated by the decision of other OPEC members to rescind a planned la-percent production cutback decided upon before the outbreak of the war. Productivity growth may be slower in the early stages of the forthcoming recovery than it was during the 1 975-76 recovery period, in view of the widespread expectation of slow growth in business activity over the period ahead. But if productivity growth reaches an annual rate of (say) 3 percent, and compensation reaches a rate of (say) 1 0 percent, then labor costs should rise at about a 7-percent rate four quarters into the recovery period. A movement of that type would cut the laborcost increase in half from the second-quarter 1 980 figure-but unfortunately, itwould also represent a much higher increase than was recorded in the early-recovery period of any previous business cycle. But this scenario is based on the assumption that the Middle Eastconflict doesn't spread beyond the Iranian-Iraqi borders. A far more serious situation could arise if the Strait of Hormuz were closed. More than one-third of the non-Communist world's crude-oil supply moves through that 24-mile-wide waterway. During the fourth quarter, meanwhile, the rate of increase in food prices should moderate somewhat as the effects of the drought subside. Prices of all items other than food That 7-percent projected rise in unit labor costs cou Id represent a proxy fQr the underly2 ing rate of inflation in the 1981 economythe increase apart from food and energy "shock" pressures on the price index. But those shock effects could add several percentage points to the underlying trend next year. Retail food prices could rise as much as 14 or 15 percent du ri ng 1981 -several points above even the high 1 980 rate-as suppl ies of Iivestock and food-and-feed crops fall somewhat below year-earlier levels. The energy situation remains a question mark, depending upon whether the production and export cutoffs resulting from the Middle East confl ict seriously erode the heavy inventories of crude ex isti ng throughout the world. If that happens, the energy component of the CPI could rise at a faster rate than in 1980. On balance, despite major shock effects, the overall price trend could improve in 1981 just as it did in the last business recovery. Still, that would leave the inflation rate at a higher level than it reached at the comparable stage of any previous recovery. Yvonne levy Cyclical Behavior of Consumer Price Index Percent Change* 18 16 14 12 10 8 6 4 2 8 *Percent change from previous quarter at annual rate. 3 1 0 Quarters Past peak u018U!4SPM"4Pln .. uo8aJO .. ppPt\aN .. o4 PPI !!PMPH .. P!UJO J!jP) .. PUOZ!J\t' .. P)ISPIV JrdI (G) {l \ill W {l JJ'Wdf 8ANKING DATA-TWELFTHFEDERAL RESERVE DISTRICT (Dollaramountsin millions) SelectedAssetsand liabilities LargeCommercialBanks Loans(gross,adjusted)and investments* Loans(gross,adjusted)- total# Commercialand industrial Realestate Loansto individuals Securitiesloans U.s. Treasurysecurities* Othersecurities* Demanddeposits- total# Demanddeposits- adjusted Savingsdeposits- total Timedeposits- total# Individuals,part.& corp. (LargenegotiableCD's) WeeklyAverages of Daily Figures MemberBankReservePosition ExcessReserves (+ )/Deficiency(-) Borrowings Net freereserves (+ )/Netborrowed(- ) Amount Outstanding Change from 9/17/80 9/10/80 139,880 118,027 34,299 47,758 23,751 946 6,465 15,388 46,437 33,466 29,600 63,843 55,378 24,360 707 619 257 214 44 67 57 31 -1,738 51 61 238 148 242 Changefrom yearago Dollar Percent - - - Weekended Weekended 9/17/80 9/10/80 19 166 186 21 136 156 - 5,556 6,862 2,291 7,019 487 1,271 1,164 142 1,870 2,984 753 9,543 9,433 4,022 4.1 6.2 7.2 17.2 2.1 - 57.3 - 15.3 0.9 4.2 9.8 2.5 17.6 20.5 19.8 Comparable year-agoperiod - 62 226 164 * Excludestradingaccountsecurities. # Includesitemsnotshownseparately. Editorialcommentsmaybe addressed to theeditor (William Burke)or to the author.... copiesof this andother FederalReservepublicationscanbeobtainedby callingor writing the PublicInformationSection, FederalReserveBank-ofSanFrancisco,P.O.Box 7702, SanFrancisco941,20.Phone(415) 544-2184. 24I C@I \\iI:D JJWJ CQI