Brooklyn's Progress
June/July 2005

By Joel L. Naroff, Ph.D.

Remember all those stories about the economy hitting a soft-spot, that growth had faltered and the strength of the expansion in the months ahead was uncertain?  And worse, the ugliest word in the economic language, stagflation, was being trotted out as inflation began to accelerate.  Well guess again.  Upon further reflection, the government data mills are now telling us there was no major slowdown and the economy is doing just fine.

Granted, there were reasons to be concerned.  Job growth had eased and indicators of future industrial activity, such as durable goods orders, were down.  But that all changed over the past month.  Solid economic reports are raising questions about whether the economy is growing so strongly that interest rates just might start rising sharply.

The key to the change was the awesome April employment report.  U.S. businesses added almost 275,000 new workers to their payrolls and it turns out that the weak jobs reports of February and March were not quite as bad as initially thought.  Only a confirmed pessimist could think that the hiring of 720,000 people in three months pointed to problems. 

With the gains being extremely broad based, it is clear that the labor market is firming and jobs are becoming more available.  Nothing helps power the economy more than a solid employment situation and it finally seems to be here.

Which brings us to the sticky issue of stagflation. This refers to a stagnating economy and accelerating inflation.  We can skip the stagnation part since we now know that conditions are good.  So what about inflation?  That is a different story.

As most of us in the real world have known for a while, prices of many of the things we buy every day are going up.  It finally appears that policymakers are beginning to understand that as well.  No matter how you measure inflation, and there are many ways of doing that, it is accelerating.

It is not just oil which is killing us.  The costs of a wide variety of goods and services are on the rise.  Critically, firms are discovering that after years of being forced to accept higher costs without being able to increase prices, pricing power has, to a small extent, returned.

Because inflation is accelerating, the Fed will likely continue tightening monetary policy. The Fed has raised rates six times since last June and there is no reason to think they will stop anytime soon. When the Fed increases rates, there is a ripple effect on many consumer rates, such as credit card and home equity lines.

Normally, when inflation picks up, longer-term rates, including mortgages, move up.  Not this time. Nevertheless, with wages and prices likely rising further, these wonderfully low rates are not likely to persist.  We know the direction.  It’s the timing we’re fighting over.

So what do we have to look forward to?  More good news on the economy, but additional increases in interest rates.

Joel L. Naroff, Ph.D., is Chief Economist for Commerce Bank. Commerce Bank, “America’s Most Convenient Bank,” is a leading financial services retailer with 320 convenient stores in New Jersey, New York, Pennsylvania and Delaware. For more information about Commerce, please visit the company’s interactive financial resource center at commerceonline.com.