Inflation Outlook

Washington Post staff writer Nell Henderson was online to answer your questions on the outlook for inflation and about her story: Rising Expenses Have Consumers Feeling Pinched

A transcript follows .

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Laurel, Md.: One reason for the inflation of the 70s that it is often overlooked is the entry of the baby boom generation into the labor force, which grew about twice as fast from 1986-80 as it did in the 15 years before or since.

Most people today are aware that the earliest boomers turn 60 this year; but the baby boom echo, begun in 1982, has just begun entering the workforce en masse before the boomers have left yet.

My real question is -- most economically informed individuals are aware of the effect the baby boom generation will have on retirement programs. But what effect will their demographic strength likely have when un-prepared seniors decide younger taxpayers owe them a better retirement?

Nell Henderson: Hmmmm. I'm not sure many economists would agree that the entrance of the baby boomers into the workforce caused inflation. Indeed Nobel Prize economist Milton Friedman said essentially that inflation is always a monetary phenomenon_ meaning too much money chasing too few goods. Most economists, including the current chairman of the Federal Reserve Ben S. Bernanke, would say the Fed screwed up in the 1970s through overeasy monetary policy (i.e. interest rates too low, adjusted for inflation.)

As for the retiring baby boomers, I'd note that seniors tend to be voters, so yes, they may have a lot of political clout in the upcoming debates over what to do about Social Security and Medicare in the long run. _

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Manassas, Va.: Realizing that no one knows the answer to this question, please give it your best guess. Where do you see the DOW one year from now and why? Thanks.

Nell Henderson: I have no idea! And anyone who gives you an answer shouldn't be trusted.

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Washington, D.C.: There seems to be an increasing tendency for people to long for some nostalgic past, but relative to say 1950, the average person lives better, unless one values smaller houses and primitive technology. Are people really worse off, or do they just think they are worse off?

Nell Henderson: I think you're right. People may grouse a bit, but there is no question that the U.S. standard of living has risen since the 1950s or 1960s. I tried to make the point in the Sunday article that some people have a rising "cost of living" because of all the extra costs they've added for cell phones, Internet service, sports club memberships, cable tv, DVD rentals etc., etc., etc. So yes, my cost of living is higher, but so is my quality of living.

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Smithfield, Va.: What will the Fed do or not do to curb inflation and maintain the value of U.S. currency?

Nell Henderson: It's not the Fed's job to manage the value of the currency.

The Treasury Department handles currency policy.

However the Fed's job is to keep inflation low, and to do so has been raising interest rates for nearly two years. The Fed will very likely raise it's benchmark short-term interest rate again at its policymaking meeting Wednesday, and possibly again in coming months.

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Mechanicsville, Md.: Hi -- My question has to do with the policy of raising interest rates to counter inflation. Doesn't that run the risk of causing the very thing it's supposed to prevent? In other words, if mortgage rates and credit card bills, etc., rise because of higher rates, doesn't that add to people's expectations of rising prices, prompting them to press employers for higher wages? A second, related, question: isn't inflation potentially a positive thing for property owners with long fixed rate mortgages? If my mortgage payment is fixed at $1200/month, don't I make out OK if that same $1200 payment in the future is worth less than it would be in today's dollars?

Nell Henderson: Hmmm, to your second question: yes, debtors benefit from inflation, to the extent that they repay their loans in dollars that are worth less. But presumably that same homeowner is a consumer, and that so-called "benefit" would be erased when he or she has to pay higher prices for food, gasoline, heating, shoes, etc. and whatever else they consume over time.

To your first question, part of the point of the Sunday story was exactly what you're asking: The irony of the fact that a policy designed to keep inflation low (raising interest rates) can create the perception among consumers that "the cost of everything is rising." And yes, consumers who do not define inflation as technically as economists would no doubt love to press for higher wages to cover all these rising costs. But so far, there has been no sign of inflationary pressures from rising wages. On the contrary, wages for most workers have lagged inflation for the last year.

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Laurel, Md.: You mention briefly in your article one distortion that always gets me -- the way certain parts of the inflation rate are measured to reflect macroeconomic changes and not the effect on household budgets.

The government uses a hedonic index to measure the price of computers, e.g how fast they are. When I get a new PC every three years, it's usually about 5x as speed and memory as the old one. The government shows this as PC's dropping 80% in three years. But I can't replace mine with an equivalent one that costs 20% as much -- I have to spend the same money for one five times as powerful.

Does five times the power make it five times as useful to me? Of course not. I can't type five times as fast, for instance.

Nell Henderson: You are absolutely right, when it comes to computers, cars and some big ticket items where the price doesn't seem to come down, but the same price buys more bells and whistles over time. But with a lot of consumer electronics_ phones, TVs, cameras, DVD players_I think as a cheap consumer that it seems to pay to wait. The first people to buy the new gadget will pay more, but I know if I wait a while the price will come down.

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Bowie, Md.: Business news says the wholesale price of petroleum is steady today. If gasoline levels off at $3.00 for several years, should inflation drop to about the 3% level of the last couple decades?

Nell Henderson: Inflation (measured by the consumer price index, or CPI) was was 3.4 percent in the 12 months that ended in March, the same rate of all of last year. Not so bad historically, but the highest in five years. Much of that is due to higher energy prices. So, if energy prices level off, inflation may fall.(i.e. prices would rise more slowly)

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Bethesda, Md.: Now that Ben Bernanke has held the reigns for a few months is he having much influence over the state of our economy - or are there too many outside factors that we'd be experiencing these high costs if Greenspan had not retired. Or is it still way to early to tell?

Nell Henderson: Bernanke has only been Fed chief since Feb 1 and has presided over just one Fed policymaking meeting in March, so it's really too early to give him much credit or the blame for what's going on economically. However his words have roiled financial markets.

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India, China: How does the Fed deal with these two growing economies? We have good relationships w/the Japanese and European central banks - we may not always agree about tactics, but we more or less have the same ideas about where things should be going. I'm sure the Chinese would disagree with us a lot. And I have no idea how the Indian central bank operates, or how convertible the rupee is.

Nell Henderson: Well when you ask how the Fed "deals" with them, I'm not sure exactly what you mean. But I'll try. Fed officials meet frequently with their counterparts from other economies, large and small, all the time. They compare notes, analyses, forecasts, discuss banking regulation etc. But the Fed doesn't try to manage their economies.

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Austin, Texas: Why does the inflation rate seem to exclude the prices of items that everyone must purchase such as food and oil products?

Nell Henderson: Well there are many different measures of inflation. The general public, politicians and the press give the most attention to the Labor Department's consumer price index (CPI)and the so-called core-CPI, which excludes food and energy. So they are well aware that inflation, including food and energy, is running at around 3.4 percent a year. But they also look at the core rate for a sense of underlying inflation, which has been running at around 2 percent a year for a while. The roots of this practice date to the 1970s, when food and energy prices were very volatile. In recent years, food and energy prices have tended to rise consistently rather than swing up and down.

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Baltimore, Md.: What about the building trade? Will it get better or worsen? And the gas ... will it come down and how much?

Nell Henderson: Sorry I'm not a forecaster. But I think it's safe to say that if the housing market cools, as most real forecasters expect, the building trade will cool as well. But so far, it seems to still be very strong. And gas is a wild card, since oil prices are influenced by supply and demand, global geopolitical tensions, the weather, investors etc. Anything could happen.

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Anonymous: Are you an economist, or have you checked your findings with a number of liberal and conservative economists?

Nell Henderson: I am not an economist, I'm a reporter. So everything I'm telling you comes from reporting, which is based on the publicly available government data, reading, interviewing (both liberals and conservatives!) etc.

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Harpswell, Maine: With the price of energy and some base metals, like copper and gold, continuing to increase in price do you think consumers are adequately prepared for more inflation?

Nell Henderson: Well although commodities prices are rising, they haven't passed much into consumer prices yet. One exception is prices for gold jewelry. But in general, consumers say in surveys and individual interviews that they expect prices to go up somewhat, but not much, over time.

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$$ Deval Effect -- Oklahoma City : Thank you for taking our questions in advance, Nell.

I am wondering what effect, if any, the devaluation of the dollar will have on inflation.

Take care.

Nell Henderson: You're welcome!

Short answer, a lower dollar may push inflation up a tiny bit, but probably not much.

Longer answer, according to the textbooks, a falling dollar means higher prices for imports. That is inflationary for two reasons: we pay more for the imported good, and U.S. producers of that good can raise their prices too and still be competitive. But it hasn't worked out that way in the real world recently. Many times, foreign producers respond to a falling dollar by cutting prices of their goods so they stay competitive and hang on to their U.S. market share. Some would rather lose money than give up market share.

At the same time, a lower dollar should boost U.S. exports.

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Savage, Md.: What elements cause inflation (as in the 70s) to become a perpetual part of the economic landscape requiring severe measures to constrict; as opposed to something that happens for a relatively short time and then falls back to a natural, normal level?

Nell Henderson: Two things: Overeasy monetary policy and consumer expectations of high inflation.

If the Fed keeps interest rates too low, businesses and consumers may spend so much that demand for goods and services rises faster than the supply, the economy overheats and prices just keep rising.

And if consumers see inflation is high, and they expect prices to keep rising, then 1)there is a big incentive to buy now rather than later, which adds to demand and 2)it makes it easier for businesses to raise prices.

Think about the stories you've read about countries with hyperinflation where people run around spending their paychecks as fast as they can before they shrink in value, while shopkeepers post the prices on blackboards so they can raise them several times during the day. It gets crazy, both economically and psychologically. That's one reason the Fed has to sound (and be) so tough, to make sure this kind of cycle never gets started.

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Nell Henderson: It's after 3 already, so I guess I have to wrap up. But let me say, one reason it's so rewarding to write about economics in The Washington Post is that the readers are so sophisticated.I'm so sorry I couldn't get to all the questions. I've been typing as fast as I can. This is a bit like taking a pop quiz in front of thousands of professors! Thanks for your time and thought-provoking comments.

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