Rising wages raise concerns about arrival of inflation

Behind yesterday's reports of strong economic growth and rising wages lurks a question that has gotten a negative response again and again during the record 1990s boom: Is inflation back?

All it takes is a glimmer of rising prices for investors to decide that good economic news is bad.

That's what happened early yesterday. Prices plunged on Wall Street at the start of trading on news that the United States economy grew at a handsome pace from January through March and that workers were getting sizable gains in wages and benefits.

The report fueled investor concerns that the Federal Reserve will lay down its anti-inflation law even harder - meaning a big interest-rate boost when its policymakers meet May 16. The Fed has raised interest rates by a quarter of a percentage point five times since last July.

"These numbers will provide all the cover they need to raise rates May 16," says Tom Schlesinger, director of the Financial Markets Center in Philomont, Va.

"Almost everybody would be astounded if the Fed didn't."

Indeed, some analysts foresee a half-point rise in rates to rein in the economy.

But not all economists agree, and at press time investors were still trying to sort out the danger. Prices recovered on the closely watched Nasdaq market.

Stirring concern was the report that consumer spending in the January-March quarter rose at a whopping 8.3 percent annual rate, the biggest jump in 17 years. This pushed up gross domestic product, the nation's total output of goods and services, to a 5.4 percent annual growth rate after inflation.

Still, this was less than many economists anticipated.

Richard DeKaser, chief economist of National City Corp. in Cleveland, confesses to being surprised. He had forecast a 5.9 percent annual rate. But "we are still talking about a very strong pace of growth."

The Fed would prefer a 3.5 to 4 percent growth rate, seeing that as more sustainable without spurring inflation.

The cost of labor was also up sharply. The employment cost index rose by 4.3 percent in the 12 months ending in March, the highest rate since 1991.

Here, the major factor was a jump in medical costs. The index measures changes in benefits as well as wages.

Because of that, Cynthia Latta, an economist at Standard & Poor's DRI, a consulting firm in Lexington, Mass., says the Fed has no reason to raise borrowing costs more than its usual 0.25 percentage points next month.

But at present, the 12 voting members of the Federal Reserve's Open Market Committee - which determines monetary policy - are all hawks in the fight against inflation, according to Mr. Schlesinger.

The new statistics, economists note, show that productivity continued to improve at a fast rate in the first quarter. Such productivity gains offset the higher wage and benefit hikes. Thus, extra real costs to companies may be rising only 1 to 1.5 percent.

But Fed Chairman Alan Greenspan has testified before Congress that such productivity gains, in the short run, can boost stock prices, encouraging consumer spending, and add to inflationary dangers.

Schlesinger terms that thesis "bizarre."

The GDP numbers also point to the worsening of the US trade deficit. In the first quarter, it amounted to a record 4.1 percent of GDP, notes Charles McMillion, a Washington economic consultant.

The Fed's interest-rate hikes had an echo in Europe. Concerned about a decline in the value of the new unified euro currency, the European Central Bank announced its third rate hike of 2000 on Thursday. It also has been boosting short-term rates by 0.25 percentage points each time.

By raising rates, the ECB hopes to tempt European and other investors to keep their money invested in euros rather than better-paying dollar investments. The euro is worth only about 91 cents, down significantly from $1.14 after it was first issued in January 1999.

In the US, the Commerce Department also noted that the GDP deflator - the broadest of all measures of inflation - was up at an annual rate of 3.2 percent in the first quarter, the largest gain since a 3.5 percent rate in the third quarter of 1994.

"A decided turn for the worse," Mr. DeKaser says.

Schlesinger, however, blames the rise on a one-time hike in oil prices and continued increases in home prices, which may not persist.

"I am leery of seeing labor-market costs as the culprit," he says.

(c) Copyright 2000. The Christian Science Publishing Society