Producer Prices Fall: Inflation Will Be Tame in 2006
By Dr. Peter Morici, Professor of International Business

Today, the Labor Department reported the Producer Price Index fell 0.7 percent in November, thanks to falling energy prices.

Core producer prices producer prices less food and energy rose a modest 0.1 percent.

The economy has absorbed the shocks of Hurricanes Katrina and Rita, and these have not added to inflation.

The report indicated the recent surge in energy prices did not spread to nonenergy goods and services that reach final consumers. The index for finished goods, less energy and food, rose a modest 0.1 percent, and prices for final consumer goods, less energy, were up only 0.2 percent.

The latter two indexes are good predictors of future consumer price inflation, and these indicate core consumer prices will not increase much in 2006.

Going forward, consumer price inflation will be tame. Gasoline prices fell through October and November have risen only modestly in December. A warm November helped boost natural gas stock building, and this will moderate some of the run up in heating costs expected this winter.

The spurts in energy prices that followed hurricanes Katrina and Rita have significantly receded. The impacts of higher energy costs have been overwhelmed by recent improvements in productivity, permitting businesses to absorb most increases in energy and material costs before those reach final consumers. Consider, for example, how many E-tailers are offering free shipping.

Coupled with recent reports of low consumer price inflation, falling producer prices indicate the Federal Reserve can worry less about inflation going forward. Coupled with slowing automobile sales and the modest gains in retail sales this holiday season, this cooling of inflation indicates the Fed interest rate increases should end soon.

The Fed will increase the Federal Funds rate to 4.5 percent when it meets in January; however, further pushing up interest rates would risk slowing growth too much and raising unemployment well above 5 percent.

The housing market is weakening and will likely see falling prices this winter.

Pushing the Federal Funds rate past 4.5 percent would risk pushing down housing prices down significantly and a recession.