Inflation Study Disputes Role of ‘New Economy’

A new Federal Reserve Bank of New York research paper debunks “new-economy” claims that rising productivity and technological advances have permanently altered the relationship between U.S. growth and inflation.

The paper, written by two bank research economists, said falling import prices--aided by cheap oil and Asia’s recent financial crisis--played the key role in capping U.S. inflation in the last few years.

“We find that conventional economic forces, comparable to those that have shaped inflation behavior in the past, can account for the restraint that has characterized U.S. inflation over the last decade,” the paper written by Robert Rich and Donald Rissmiller said.

Though the U.S. economy has been growing for an unprecedented 9 1/2-year stretch and gathering extraordinary momentum in the past few years, core inflation excluding food and energy costs has been on a downward track.

This surprisingly tame inflation has led proponents of the “new economy” to contend that increased global competition, rising productivity and advances in technology are enabling the economy to grow at much faster rates without generating inflation.

“According to this explanation, the low inflation rates reflect a permanent change in the dynamics of the inflation process,” the two men wrote in their paper.

But they found that more traditional factors were probably still at work, specifically “supply shocks” that influence inflation through sharp changes in business costs.

“Supply shocks may take on greater relevance as the increased openness of the U.S. economy exposes domestic producers . . . more fully to shifts in the prices of imported inputs and final goods,” the report said.

The paper found that U.S. import prices fell at an average annual rate of 6.4% from 1995 to early 1999, thanks to falling oil prices, a strong dollar and the 1997-98 Asian financial crisis that resulted in cheaper prices on Asian exports.

The authors also concluded that the impact of wage increases and exchange rates on inflation in the short run may be overstated.