Prices paid to producers rose an unexpectedly sharp 1.1 percent in September, the Labor Department reported yesterday, raising concern about inflation in financial markets and sparking a broad sell-off on Wall Street.
But, according to many analysts and some policymakers, the long-running U.S. economic expansion is not headed for serious trouble. Interest rates are on the upswing, these analysts say, precisely because the economy remains strong, but they foresee no big breakout of inflation. And the decline in stock prices has so far come in the form of an orderly, gradual correction, not a sudden crash. Even the producer prices report reflects seasonal and other anomalies that are likely to be reversed in the coming months.
While no Federal Reserve official is likely to say publicly that the stock market's correction is a good thing, privately many regard it as a healthy development for a market that by most historical measures of value was significantly overpriced.
Fed Chairman Alan Greenspan has said repeatedly that the central bank has no way to know for sure whether the level of stock prices at any given moment is justified by expectations of future increases in corporate earnings. If there is a market "bubble," there is no way to know it and therefore nothing the Fed can or should do in advance of a bubble bursting. Were that to happen, the Fed would help soften the impact on the overall economy by reducing interest rates, Greenspan has promised.
In a speech Thursday, the Fed chairman reiterated warnings that executives responsible for managing the risks that financial institutions assume in their lending and other activities must take into account that investors can suffer a sudden, wholly unexpected loss of confidence. When that occurs--as it did in the summer of 1998 when the Russian government defaulted on part of its debt--a financial crisis can ensue and cause the value of all types of assets to fall sharply.
Greenspan didn't say he believes such a crisis is likely to strike again soon; only that risk managers should keep in mind that it could happen. Nevertheless, his remarks contributed to yesterday's further drop in stock prices.
But the Fed has also been concerned about the boom in stock prices because of the enormous increase in personal wealth created by the rise in equity prices, which has encouraged both businesses and individuals to spend at a rapid pace. With unemployment of only 4.2 percent, a near 30-year low, and the pool of unemployed workers who want a job steadily shrinking, Greenspan and other Fed officials would prefer that the rate of consumer and business spending subside before inflation takes hold again.
So far, there are nascent signs of such a slowdown, but the economy grew at a better than 3 percent pace in the July-September period and appears likely to do so again in the final three months of the year, forecasters believe.
Continuing solid growth is the key reason interest rates have moved higher. In June and again in August, Fed officials voted to raise their target for overnight interest rates out of fear that if growth doesn't slow, inflation pressures will increase. Some analysts regarded those actions as the Fed's taking its foot off the accelerator; others said it was a gentle tap on the brakes.
Then at a subsequent meeting early last week, Fed policymakers left rates unchanged but did announce they were leaning in the direction of raising rates again. But they emphasized there was no commitment to increase rates.
The Fed's announcement last week showed policymakers are concerned wage costs could increase at a rate greater than can be offset by increases in worker productivity. If that occurred, higher inflation could develop and "undermine the impressive performance of the economy."
However, a number of analysts said that scenario doesn't appear likely to develop.
"If Wall Street's third-quarter profit estimates are to be believed, corporate profits rose impressively, almost certainly confirming that productivity growth continues apace," said economist James Glassman at Chase Securities Inc. in New York. "Rising wages and material costs represent no inflation threat if profit margins are expanding amid relatively stable inflation."
On the surface, that view got a strong challenge yesterday when the Labor Department reported that producer prices for finished goods shot up 1.1 percent last month, the largest monthly increase since the fall of 1990 when oil prices skyrocketed during the Persian Gulf War. Price increases for food, energy, tobacco products and new cars were responsible for most of the unexpectedly large increase in the index.
"The PPI came in much worse than expected, but it is not as bad as it seems," said economist Gerald D. Cohen at Merrill Lynch & Co.
Cohen and other analysts said that special factors, including seasonal adjustment problems with the new car figures, greatly inflated the month-to-month change and that the price report did not signal the beginning of a major outbreak of inflation. Both the increases in energy and new car prices are likely to be reversed next month.
In a separate report, the Fed said industrial production fell 0.3 percent last month because of disruptions caused by Hurricane Floyd.