Smith Faculty Opinion Article	March 16, 2007
By Dr. Peter Morici, Professor of International Business E-MAIL WEB SITE

Producer Prices Rise 1.3 Percent in February
No Change in Federal Reserve Policy Likely

Today, the Labor Department reported the Producer Price Index rose 1.3 percent in February, after falling percent 0.9 January.

Energy prices rose 3.5 percent, after falling 4.6 percent in January. Food prices rose 1.9 percent, after rising 1.1 percent in January.

Core producer pricesproducer prices less food and energyrose 0.4 percent, after rising 0.2 percent in January.

Over the last year, producer prices, including food and energy, have risen only 2.5 percent. Through the first half of 2007, core consumer price inflation is likely to continue above 2 percent, and energy prices will push the broader inflation indexes higher.

In February, heating oil and gasoline prices rose 6.0 and 5.3 percent, respectively, as cold weather pushed up demand. U.S. refining capacity and stocks were already stretched thin by U.S. demand and environmental policies, and pressures from breakneck growth and inefficient petroleum use in China make additional global supplies scarcer. Now, both U.S. fuel oil and gasoline stocks are well below 2006 levels, fuel prices are spiking sharply in March, and the broader indexes of producer and consumer price inflation will jump in March and April at rates Federal Reserve policymakers will find unsatisfactory.

Sadly, the policy levers at the Federal Reserves disposalhigher short term interest rateswould do little to salve these problems. Only new refining capacity, which U.S. environmentalists and Democrats in Congress will not abide, and radical adjustments in Chinese exchange and monetary policies, which Treasury Secretary Paulson and President Bush lack the stomach to accomplish, could quell pressures on global and U.S. energy markets. By permitting China to undervalue the yuan and flood global markets with liquidity, the Bush Administration has significantly limited Federal Reserve policymaking prerogatives and outsourced much of those to Beijing.

For consumers, higher gasoline prices will begin biting significantly with credit card bills that arrive later in March, and this will moderate retail sales and consumer demand generally. Coupled with the ongoing adjustment in housing prices and Chinese-inspired instability in equity markets, consumers can be expected to exhibit caution when shopping for nonessentials.

Intense competition will keep a lid on prices for automobiles, electronics and other discretionary consumer items. The slowdown in housing will leave appliance, home supply and furniture manufacturers eager to entice customers with good deals. Moderate growth in consumer incomes, higher gasoline prices and falling housing prices will force retailers to price apparel and other nondurable goods more aggressively. For retailers, excess capacity will continue to squeeze margins, instigate productivity gains and minimize pass through of wholesale prices to final consumers for most non-energy and food items.

The combination of consumers reluctant to spend as uninhibitedly as in 2006 and builders stuck with too many unsold new homes will severely challenge the economy to deliver the 2.5 percent growth many Wall Street analysts have forecasted. Business investment and commercial construction will have to stage a rally or the economy will continue to sputter along at something closer to 2 percent through the first half.

Federal Reserve policymakers will face more difficult challenges accomplishing both moderate inflation and growth than anticipated earlier this year. Facing Hobson choices of tanking the economy or setting off an inflation spiral, the best policy course will be to do no harm, and leave the economy to its natural dynamics.

Look for no change in Federal Reserve interest rate policy before August, GDP growth to continue on the moderate path of the last three quarters until mid 2006, and some surge in inflation. In the second half, growth should improve to about 3 percent, but inflation will be left in the hands of the Godsmore accurately to the demand for oil in China.

Peter Morici is a professor at the University of Maryland School of Business and former Chief Economist at the U.S. International Trade Commission.