Geoffrey H. Moore

English

Research Papers in Economics

This PDF is a selection from an out-of-print volume from the National Bureau of Economic Research
Volume Title: Business Cycles, Inflation, and Forecasting, 2nd ed.
Volume Author/Editor: Geoffrey H. Moore
Volume Publisher: UMI
Volume ISBN: 0-884-10285-8
Volume URL: http://www.nber.org/books/moor83-1
Publication Date: 1983
Chapter Title: Five Little-known Facts about Inflation
Chapter Author: Geoffrey H. Moore
Chapter URL: http://www.nber.org/chapters/c0697
Chapter pages in book: (p. 171 - 174)Chapter 11
Five Little -known Facts
about Inflation
FACTONE: INFLATION IS CLOSELY
TIED TO THE BUSINESS CYCLE
Everydownturn in the business cycle since 1948 has been associated
with a downturn in the rate of inflation, and every upturn in the
business cycle has been accompanied by an upturn in the rate of in-
flation, measured by the consumer price index (CPI). On only two
occasions has a decline in the inflation rate occurred during an ex-
pansion in business, but in both instances there was a marked slow-
down in the rate of economic growth. On the record, a slowdown or
recession has been both a necessary and a sufficient condition to
reduce the inflation rate. A business recovery and expansion has been
both necessary and sufficient to raise the inflation rate.
The latest business cycle upturn came in March 1975 and the up-
turn in the inflation rate followed about a year later. Its low point
was 4.7 percent, centered on April 1976. The latest rate, centered on
February 1977 (covering the six months November 1976-May
1977), was 8.7 percent. Both rates are adjusted for seasonal varia-
tions; a six month interval is used in order to smooth out irregular
fluctuations.
t
I Reprinted from The Morgan Guaranty Survey, August 1977.
J 171
I.-.=4.._
______172Inflation
FACTTWO: FOOD PRICE INFLATION
IS CLOSELY TIED TO THE
BUSINESS CYCLE
Allthe major swings in the overall inflation rate (CPI) have been
accompanied by similar swings in the rate of change of food prices.
Although weather and crop failures have had important effects on
food prices at times, most of the major swings in food price inflation
have been closely tied to the business cycle. One of the reasons is
that food prices respond quickly and sharply to the changes in de-
mand associated with the business cycle. In recession, employment
and incomes decline, and this holds food prices down. In prosperity,
rising employment and incomes pull food prices up. Another reason
is that foods, especially processed foods, contain a significant labor
cost component, and this is likely to move up and down with the
business cycle, regardless of food supply conditions. The food infla-
tion rate reached its low point (virtually zero) in January 1976, ten
months after the business recovery began and has been rising since.
The latest rate, calculated in the same way as for the overall rate, was
12.1 percent (seasonally adjusted annual rate, November 1976-May
1977).
FACTTHREE: THE WHOLESALE PRICE
INDEX IS NOT A GOOD FORECASTER
OF CONSUMER PRICES
Onlya small part (about 30 percent) of the wholesale price index
(WPI) is directly related to the prices paid by consumers. That is the
part labeled "consumer finished goods." The rest—raw materials,
machinery, and the like—is not bought by consumers. Moreover, the
WPI for consumer finished goods, which includes things like foods
and shoes, applies to only a part of what consumers buy—namely,
commodities. Services such as housing (rent, mortgage interest) and
medical care are not covered by the WPI at all, but are included in
the CPI.
When the two comparable parts of the WPI and the CPI are com-
pared (WPI consumer finished goods and CPI commodities) for the
period covered by both (1956 to date), it turns out that the rate of
change in the former typically leads the latter by a month. This hap-
pened at five of the ten upturns or downturns in the two rates since
1956. At two of the other five turns the two rates were very close
together; at the rest they were rather far apart. Hence the WPI con-
sumer finished goods component provides a good check on what the
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commodityprice component of the CPI is doing or is about to do,
but not much of a forecast.
As for the rest of the WPI, the most useful "leading indicator"
visà-vis the consumer price index is the WPI for crude materials ex-
cluding foods, feeds, and fibers. This covers the materials and fuels
e been that enter into the cost of production of many consumer products
prices and is highly sensitive to shifts in demand and supply that later affect
acts consumer prices. The rate of change in this index has led the rate of
flation change inthe CPI at fifteen of the sixteen turns in the latter since
is 1948, with an average lead of seven months. The latest upturn in
jinde- crude materials preceded the upturn in the CPI rate by more than a
yment year.
perity,
eason FACT FOUR:THE EMPLOYMENT RATIO
labor ISA BETTER INDICATOR OF
th the INFLATIONARYPRESSURES THAN
infla- IS THEUNEMPLOYMENT RATE
6,ten
since. A high level of unemployment has not prevented the rate of inflation
e, was from increasing. For example, the current upswing in inflation began
-May in the spring of 1976, when the unemployment rate was around 7.5
percent. During the next twelve months the inflation rate climbed
sharply even though unemployment remained high, contrary to some
predictions that the slack in the economy would hold down prices.
This is not an isolated instance attributable to special circumstances.
Arthur F. Burns, writing in 1951 about the results of business cycle
studies at the National Bureau of Economic Research prior to World
index War II, summed it up in seven words: "Inflation does not wait for
is the full employment." After twenty-five years of more recent experience
rials, he said the same thing (less succinctly) in testimony before the Sen-
r, the ate budget committee, March 22, 1977: "The prices of final goods
foods and services gather substantial upward momentum well before full
mely, utilization of resources is achieved."
)and Although the rate of inflation has not been closely correlated with
ed in the unemployment rate, it has been more closely correlated with
another measure of labor market tightness—the employment ratio.
corn- This is simply the percentage of the population of working age that
r the have jobs. Naturally it moves in the opposite direction to unemploy-
te of ment, but the significant difference is that it takes into account shifts
•hap- in labor force participation as well. Sometimes, as in recent years, a
since high level of unemployment is accompanied by a high level of em-
close ployment, which means that more persons are in the labor force and
con- fewer outside of it. The result is that labor markets are tighter than
the174Inflation
theunemployment rate, taken by itself, suggests. For example, in
late 1973 and early 1974 the employment ratio reached an all-time
high, even though the unemployment rate, at 5 percent, was not
especially low. The high demand for labor pushed up wage costs,
and the higher earnings pushed up demand for goods; both factors
pushed up the rate of inflation. Similar forces are at work during the
present recovery. The employment ratio is at a higher level than at
any time prior to 1973, and the inflation rate is at the level reached
early in 1973.
FACTFIVE: FORECASTS OF THE
INFLATION RATE HAVE BEEN
A LAGGING INDICATOR OF THE
ACTUAL RATE
Economistshave been aware for many years that the rate of inflation
tends to perpetuate itself. Once inflation gets going, it tends to keep
going. Hence one can do pretty well by forecasting that next year's PREF inflation rate will be the same as last year's. The forecaster simply
takes advantage of the inertia in the price system. The trouble is that The
forecasts made on this plan inevitably lag behind events. When the annive
actual rate of inflation accelerates, the upturn will be missed. When Burea it decelerates, the downturn will be missed. That is, the turn will cyclic not be identified before or at the time it happens, but only after it erick
happens. Georg
A record of economists' forecasts of the rate of change in the con- Robe
sumer price index, compiled since 1947 by Joseph Livingston of the matio
Philadelphia Inquirer, demonstrates this tendency. Only twelve of about
the sixteen turns in the inflation rate between 1947 and 1976 were izatio
recognized by the forecasters at all, and at ten of the twelve the fore- nomic
casts lagged. The average lag was six months. At the latest upturn the The g
forecasts were ten months late. Perhaps more attention to the rela- agains
tionships discussed above will help to improve the record. whole
marke
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Business Cycles, Inflation, and Forecasting, 2nd ed.

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