"Is Inflation Dead?" by Roger E. Brinner, in The New England Economic Review (Jan.–Feb. 1999), Research Dept., Federal Reserve Bank of Boston, P.O. Box 2076, Boston, Mass. 02106–2076.

The American economy has lately seemed to defy the economists’ gloomy wisdom that a falling rate of unemployment eventually leads to a rising rate of inflation. Employers, the theory says, start competing for scarce labor by offering higher wages. The last few years have brought both very low unemployment (under five percent) and declining or steady price inflation. Is this because workers, more insecure perhaps because of the well-publicized layoffs of the early 1990s, have become reluctant to demand higher wages? No, argues Brinner, chief economist of the Parthenon Group, a Boston-based consulting firm. The happy situation today is due simply to good luck.

"Inflation is not dead," he asserts. Workers’ real wages have been rising faster "in response to low unemployment, just as in past decades." While nominal wage inflation remained relatively stable in 1997 and ’98 at around three to four percent, real wage inflation began rising in late 1996.

If that is so, why haven’t prices been following suit, as employers seek to cover the higher costs that rising wages represent to them? The answer, Brinner says, is that price inflation has been held down by some fortunate "supply shocks." These include:

• Falling oil prices. "After rising sharply in 1990, oil prices declined in the early 1990s. They jumped up in 1996 but retreated in 1997 and plummeted in 1998."

• "Lower costs for imported goods because of a strong U.S. dollar. Besides their direct effect, lower import prices also cut component costs and increase competitive pressure on domestic producers."

• A rising stock market has cut pension costs for employers providing defined benefit pension plans.

• Inflation in health care costs has been reduced because of changes in the industry resulting from increased competition and pressures from employers and government.

"Prices reflect total labor costs, not just wages," Brinner notes. "Therefore, any surprise reduction in the cost of fringe benefits relative to base wages would also trim price inflation."

Usually, "unemployment is the dominant influence on inflation," Brinner observes. In the late 1980s, however, a surge in inflation took place that, while frequently blamed on the drop in the unemployment rate to 5.3 percent, "was actually due to a confluence of adverse inflation shocks" from other sources, including rising prices for oil and other imported goods.

"Conversely," Brinner says, "the moderate inflation of recent years is due to a confluence of beneficial shocks from all factors other than unemployment." Were it not for the declining prices of imported goods and energy, and the slower growth in the cost of fringe benefits, the tight labor markets in 1997 and 1998, he says, would have added perhaps a full percentage point to the wholesale price index. In short, he concludes, the good fortune of recent years "[does] not herald a new economy, forever destined to enjoy high growth and low inflation."