Roanoke Times
Copyright (c) 1995, Landmark Communications, Inc.
DATE: SUNDAY, November 14, 1993 TAG: 9311100273
SECTION: BUSINESS PAGE: F-1 EDITION: METRO
SOURCE: John Levin
DATELINE: LENGTH: Long
It may seem silly to bemoan the loss of a financial evil, but without inflation, the illusion of well-being is gone for many Americans.
First Union Corp. economist David Orr called it a sobering hangover to see salaries and savings grow by puny rates compared to returns of just a few years ago.
"You have to realize that you're better off with a 3 percent raise if the prices of what you buy are steady, than if your salary goes up 8 percent and prices of what you buy go up 10 percent," he said.
For both consumers and businesses, the absence of serious inflation in the economy requires some new strategy about investment and spending.
Ordinary household spending likely is not much affected. Except in periods of hyperinflation, families continue buying pretty much the same food, clothing and even big-ticket goods, said Vittorio Bonomo, associate professor of finance at Virginia Tech.
"The real effect is on where you invest your money," he said. Low inflation rates tarnish the investment value of what for most families is their major investment: their homes, he said.
In the past two decades, many families have bought houses larger or more expensive than they needed, assuming that rising values would make owning them solid investments. But "you must look at your home as a consumer good," he said. "With the lack of inflation, it means anyone can build that same house in 10 years for the same price. To sell, you'll compete with new houses" at the same price.
A better place to put money, Bonomo said, is the stock market, where it might gain the advantage of companies making productivity gains and grabbing more global business by holding down prices.
Major discretionary purchases will be approached more soberly by many families, said Noreen Klein, associate professor of marketing at Virginia Tech. Consumers who may have jumped quickly to beat inevitable price hikes in times of high inflation, now will think longer and harder before buying homes, cars and appliances or taking expensive vacations.
"Consumer expectations about income in the future will drive purchases" and job security with likely weigh more heavily that the fear of rising prices, she said.
"Low inflation definitely is a positive factor of a lot of people. But coming with the uncertainity about employment . . . is making them more conservative," Klein said.
Also, consider that conspicious consumption of the 1980s is out of style, replaced by buying for good value. That's likely to prod the purchase of what marketers call small luxuries, such as gourmet coffee, that allow consumers reward themselves without spending a lot of money.
Companies, said Orr, also must adopt more hard-nosed attitudes. "The ability to continue to grow your profits when you can't increase prices is what separates the men from the boys," he said.
Many American corporations have used inflation as an economic crutch, Orr said. A bad decision or a mismanaged factory could be bailed out by inflation's illusion of growth. Today's painful retrenching by some major companies is the result of removing expense structures that required inflation to maintain growth of revenue, he said.
Economic growth without inflation, however, is the norm of America's economy, Orr noted, if more than the past 20 years are remembered. In fact, in the period between the Civil War and the Great Depression, there were as many years of declining prices and interest rates as years of inflation.
In case there's doubt about the Federal Reserve Board's success in killing rampant inflation as a factor in the U.S. economy, consider these recent indicators:
The producer price index, the measure of inflation at the wholesale level, fell 0.2 percent in October, the fifth time in the past six months the figure has dropped or held steady. The most recent figure, the Labor Department said Tuesday, means wholesale prices are rising at 0.4 percent this year, compared to 1.6 in 1992.
Consumer prices, according to the index reported Wednesday, rose 0.4 percent in October, largely fired by energy prices that rose with the new federal gasoline tax. For the first 10 months, however, inflation is 2.8 percent, well below rates consumers learned to live with for much of the past 15 years.
Interest the government will pay on savings bonds was set this month at 4.25 percent. It is the lowest rate since variable-rate bonds, based on other market rates, were first sold in 1982.
Pensioners will receive 2.6 percent increases in Social Security and railroad retirement annuities beginning in January. The small increases reflect annual changes in the Consumer Price Index under a program designed for so-called fixed-income retirees to keep pace with inflation.
Assuming no major shocks to the economy, such as oil shortages or war, major econometric forecasts look for average annual inflation of 3.6 percent through 1997 and 3.9 percent from then through 2002, said Roy Pearson, director of the Bureau of Business Research at the College of William and Mary.
Some other factors could push inflation even lower, he said. If health-care costs are brought under control, government is reformed, and global markets for U.S. goods grow, "there could be a huge reallocation of resources and some very large shifts of who spends and what gets bought," he said.
John Levin is business editor of the Roanoke Times & World-News.
by CNB