Rising Inflation Was Forecast Well Before
the Markets Tanked

Investors who were clobbered by the stock markets' nosedive in mid-April should have been listening to professional economic forecasters. Economists got it right this time when they read the tea leaves in March and early April and found pervasive signals that prices were marching upward. Equity markets were already nervous that the U.S. economy was still growing faster than the Federal Reserve Board would tolerate in its pursuit of price stability. Five consecutive rate hikes by the Fed have hardly dented either growth rates or consumer optimism. However, the official announcement on April 14 that consumer prices jumped by 0.7% in March (0.4% on the core index, which excludes the more volatile food and energy components) seemed to catch investors and market analysts by surprise. The inflation figure was nearly double what market analysts were reported to have expected. The unwelcome news pushed investors into a panicky sell-off, and triggered margin calls on much of the $250 billion of margin credit owed by individual investors. The week of April 10-14 gained the dubious distinction of the worst week in the history of U.S. equity markets. The Nasdaq exchange lost 26% of its value in just one week (ending the week down nearly 35% from its all-time record just a month earlier). The Dow Jones Industrial Average was down 12% from its own high.

Should analysts have seen it coming? Two groups of professional economic forecasters had released survey results that foreshadowed the government's inflation report. In March the National Federation of Independent Business (NFIB) released its survey of small business owners nationwide. In early April the National Association for Business Economics (NABE) released a survey of business conditions as seen by its own, generally much larger corporate members. The most striking result of both surveys was distinct upward pressure on selling prices.

Interestingly, both surveys found continued optimism among responding firms. The NABE panelists reported demand for products and services at their firms was still growing during the first quarter of 2000 but at a slightly slower pace than in the fourth quarter of 1999. Profit margins remained intact at about the same level as late last year. However, the more disturbing news, especially in retrospect, was the report that costs for both labor and materials accelerated during the first quarter of this year. In particular, wage increases were the largest since 1989, not surprising since skilled labor shortages existed at 66% of reporting firms, the highest reading in more than three years. Consequently, cost increases were apparently passed along in the form of higher prices. The NABE reported that the net percent of firms reporting increases in their prices was the highest in four years. More importantly, 94% of the firms who attempted to raise prices were able to make them stick. Diane Swonk, NABE President and Chief Economist for Bank One Corporation said "we have seen a distinct upward shift in pricing momentum in recent months, particularly in the ability of firms to realize planned price increases . . . This, coupled with worsening shortages, and a further tightening of labor market conditions, suggests that inflation pressures extend beyond the oil-based inflation seen in the first quarter."

The experience of small business owners mirrored that of larger corporations. The seasonally adjusted net percent (percent raising minus percent lowering) of firms reporting higher average selling prices more than doubled in March to 16 percent of all firms, the highest reading in a decade. NFIB Chief Economist William Dunkelberg noted that these price pressures are still modest compared to the "inflation days" of the 1970s, when over 70 percent of firms often reported higher selling prices. "However," he commented, "it does appear that the best inflation years are now behind us." The NFIB's Index of Small Business Optimism rose slightly in March, in part because of stronger profits. But, small business owners' plans to hire, increase inventory and make capital outlays "all faded on a seasonally adjusted basis." Dunkelberg noted the following developments from the survey that will shape the economy for the rest of the year:

• Hiring plans feel to 14 percent of all firms (net of those planning reductions), 8 points below December's record.
• Twenty-three percent of all firms reported that finding qualified labor (skilled or unskilled) is the most important problem faced by their firm. Thirty-three percent reported hard-to-fill job openings. Both are records.
• Thirty-two percent reported higher labor compensation, a record. Only 8 percent cited labor costs as the number one business concern.
• A net 16 percent of all firms reported raising average selling prices. The average for 1999 was 5 percent.
• Capital spending plans were reported by 37 percent of all firms. The record is 41 percent set in December, 1998.