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To: faro who wrote (22209)	7/28/2000 10:48:29 AM
From: pallmer	Read Replies (1) \| Respond to of 77509

[B] FED JOURNAL: Low inflation of '90s likely not permanent change By Deborah Lagomarsino, Bridge News New York--July 28--While many analysts believe the low inflation rates of the 1990s represent a fundamental change in the relationship between inflation and economic growth that may last, it is conventional economic forces, such as supply shocks, that have kept a lid on inflation over the past decade, New York Federal Reserve economists asserted in a recent research paper. * * * In a paper entitled "Understanding the Recent Behavior of U.S. Inflation," New York Fed economists Robert W. Rich and Donald Rissmiller argue that one supply shock in particular, a large and protracted fall in relative import prices, has proven "especially important" in curbing inflation over the past few years. "The recent low rates most likely stem from conventional economic forces, not from a fundamental and lasting change in the U.S. inflation process. Of these forces, a large and persistent decline in relative import prices has proved especially influential in recent years," the authors assert. The authors point out that the decline in relative import prices starting in the middle of 1995 has the "requisite timing and magnitude to explain the steady behavior of core inflation" in the later part of the 1990s. They point out that the path of inflation has closely tracked the rise and fall of relative import prices from the third quarter of 1995 to the first quarter of 1999. During this period, relative import prices, influenced by lower oil prices, a firming dollar and the Asian financial crisis, fell at an average annual rate of 6.4%. To gauge how much of an impact changes in relative import prices had on inflation versus other factors, the authors used a forecasting model. In it, they charted relative import prices, the behavior of past inflation and the level of demand in the U.S. economy as reflected by the unemployment rate and compared these factors to the actual inflation rate over the past 10 years. What they found was that without factoring in changes in relative import prices, neither past inflation performance or the level of demand in the economy as measured by the unemployment rate was able to account for the behavior of inflation in the 1990s. "Our results confirm that supply shocks and other conventional economic factors, rather than a change in the inflation process itself, underlie the low rates through the end of 1999," the authors write. Rich said he considers the changes in relative import prices as the "missing piece" in the formula to explain the inflation performance in the past decade. "We have several factors working together. What we're simply trying to suggest is that past inflation along with the behavior of the unemployment rate in conjunction with import prices has been able to account for the recent behavior of inflation," Rich said in an interview. "These three factors working together explain the actual behavior of inflation fairly well," he added. Because the economists kept the natural rate of unemployment (NAIRU) constant in the model they constructed, another conclusion from their research is that "falling inflation and falling unemployment doesn't necessarily imply anything about NAIRU falling," Rich said. "What we're actually trying to show is that we can explain the fall in the unemployment rate and falling inflation without necessarily requiring NAIRU to fall because import prices are helping to explain part of the decline in inflation in the late 1990s," he added. Many economists have argued that because the continued slide in the unemployment rate has coincided with a continued fall in the inflation rate, NAIRU has also fallen. The theory behind the natural rate is that if the unemployment rate falls below this level, once believed to be 6.0%, it will trigger greater wage and price pressures. NAIRU is the jobless rate seen consistent with stable inflation. This is currently an issue of debate at the Fed. Federal Reserve Chairman Alan Greenspan recently stated that he believes the current 4.0% unemployment rate is consistent with price stability, while Fed Gov. Laurence Meyer believes NAIRU is at 5.0%. End [Begin BridgeLinks] Deborah Lagomarsino, BridgeNews, Tel: 212-372-7533 Send comments to econ@bridge.com [End BridgeLinks] Copyright 2000 Bridge Information Systems Inc. All rights reserved.