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To: goldsnow who wrote (35982)	6/27/1999 5:51:00 PM
From: hunchback	Respond to of 116753

Positive Economic Commentary-Friday, June 25, 1999 Paul L. Kasriel Chief Domestic Economist Greenspan Worries About Future Inflation - Is It Time For Him To Go? Maybe. But not for this reason. History suggests that Greenspan has good reason to believe that U.S. inflation is going to pick up. Consider the first chart below. In it I have plotted the year-over-year percent change in the core CPI vs. the difference between the year-over-year percent change in M3 and the year-over-year percent change in real potential GDP, as defined by the Congressional Budget Office. The percent changes are of annual averages of the variables. In its simplest terms, but not necessarily simplistic terms, inflation is the result of too much money chasing too few goods. So, the relationship between money supply growth, in this case, M3, and the economy's potential real growth just might have some implications for the behavior of inflation. In 1998, M3 increased 10.2%. The CBO estimates that the economy's potential growth rate was 2.7%. The difference between the two - 7.3 percentage points - was the largest since 1984, when it was 7.6 percentage points. Historically, faster money growth relative to potential real GDP growth has tended to lead the pick-up in core consumer inflation by three years. For this reason, I have lagged the core inflation observations by three years in the chart below. In broad terms, changes in the trend of relative M3 growth do a pretty good job of "calling" changes in the trend of core inflation - up until the last year or so. Relative M3 has been on an upward trend - admittedly from postwar low readings - starting in 1993. But relative M3 growth did not hit a "normal" level until it reached 4% in 1996. Given the historical three-year lead relationship of relative M3 growth, core inflation ought to be accelerating this year. But so far it has not. Something has gone haywire between relative M3 growth and core inflation in this current period. Some analysts believe that there has been some sort of "new era" change that has made the U.S. economy less prone to inflation now than ten or so years ago. Perhaps. But there has been something else different about the current period compared to ten years ago. That something is that the second largest single economy in the world - the Japanese economy - has been mired in stagnation over the past seven years. Also, growth in large continental European economies, such as Germany, France and Italy, has been quite tepid in recent years. Could it be that weakness abroad has had something to do with throwing off the positive correlation between relative M3 growth and core inflation? If there is general global economic weakness, it follows that the prices of globally-consumed commodities would be weak as well. And, of course, there has been a sharp decline in commodity prices recently. How do industrial commodity prices behave in relation to relative M3 growth? The chart below shows that relative M3 growth tends to be positively correlated with industrial commodity prices, and leads them by about one year. But as was the case with core consumer inflation, this relationship between industrial commodity prices and relative M3 growth appears to have broke down in the past couple of years. Now, one might be tempted to attribute the fall in commodity prices to a new era in economics. But could this explain the speed, magnitude and breadth of the price declines? The weak-global-economy explanation seems more plausible. Well, the global economy appears to be recovering. And with it, we are starting to see a recovery in industrial commodity prices, and not just oil prices. Industrial metals prices, such as aluminum and steel, have increased in recent months. The prices of wood products also have been growing. If, in fact, the economic weakness abroad has been an important element in distorting the historical relationship between M3 growth relative to potential real GDP growth and core consumer inflation, that distortion may be coming to an end. This very well could be why Fed Chairman Greenspan is starting to be more concerned about the prospects for rising inflation. ntrs.com