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A Tale of Three Supply Shocks, National Inflation and the Region's federal reserve I SSUE 2MARCH/A PRIL 1997 thwe u s o tt ss e c y onom bank of dallas A TALE OF THREE SUPPLY SHOCKS, NATIONAL INFLATION AND THE REGION’S ECONOMY N RECENT YEARS,s several supply shocks —unusual shifts in production costs —have kept U.S. inflation low by putting downward pressure on prices for certain commodities, espe- cially computers, health care and, until 1996, energy.1 Because the sectors producing these goods and services are important to the Eleventh Federal Reserve District, these shocks Ihave had an impact on its economy. After examining these shocks’ effect on U.S. inflation, this article analyzes their impact on the Dis- trict and assesses the outlook for computers, energy and health care. Supply Shocks and U.S. Inflation INSIDE U.S. inflation has remained low through early 1997, even though, Does Electronic Money since 1995, the unemployment rate has been below 5.75 to 6 percent, Mean the Death of Cash? a range below which inflation had previously tended to rise. There are three plausible explanations for this change in behavior. The Mexican Economy One is that job uncertainty has held down wages.2 Another is that the Snaps Back competitive pricings environment of the 1990s has enabled the econ- Chart 1 As shown in the upper panel of Overall and Core Inflation Chart 2, medical inflation resumed Supply Shocks and the Region Diverge in 1996 … falling in late 1995 after leveling off Year-over-year percent change over mid-1994 to early 1995. Indeed, Each of these supply shocks has 4 medical inflation has declined more affected Eleventh District employment 3.6 than overall inflation has in the mid- trends. With respect to computers, ad- Overall 3.2 1990s, reflecting the shift toward man- vances in technology have spawned 2.8 aged health care and the adoption of an increased demand for information 2.4 Core other cost-saving practices. equipment and, until late 1995, a con- 2 In the mid-1990s, the pace at which comitant rise in production and capac- 1993 1994 1995 1996 computer prices have fallen (deflation) ity. Indeed, as semiconductor orders … As Energy Price Swings has swung substantially. After slowing continued to exceed shipments, re- Drive Overall U.S. Inflation sharply in 1994, deflation in the “elec- flected in a domestic book-to-bill ratio 7 Year-over-year percent change tronic computers” category of the pro- above 1, high-tech manufacturing job 10 ducer price index accelerated sharply growth was very strong in District states 8 (middle panel, Chart 2 ), partly reflect- (Texas, Louisiana and New Mexico), as 6 8 4 ing technological advances in computer shown in the upper panel of Chart 4. 2 chips as well as excess plant capacity However, as demand growth for 0 and inventory buildup prompted by computer equipment unexpectedly –2 –4 overly optimistic expectations. These slowed in 1996, computer chip plant 1993 1994 1995 1996 wholesale price movements influence SOURCE: Bureau of Labor Statistics. retail consumer prices in the CPI’s home furnishings category, which comprises Chart 2 furniture, computers, other electronic After Pausing in 1994, omy to operate at higher capacity levels goods and home appliances. Comparing Health Care Disinflation without a pickup in inflation, or —put the middle and lower panels of Chart 2, Resumes … another way—has slowed the pace at one can see how wholesale computer Year-over-year percent change which excess demand pressures induce price deflation has influenced consumer 7.5 rises in inflation, as some of my home furnishings’ inflation in the mid- 6.5 research under way suggests.3 A third 1990s. Indeed, on a year-over-year basis, 5.5 explanation—the focus of this article— prices for home furnishings actually had 4.5 is that inflation has been low because dipped 0.1 percent as of December 3.5 several supply shocks have put down- 1996, while producer prices for elec- 2.5 ward pressure on prices for three key tronic computers had fallen 21 percent. 1993 1994 1995 1996 commodities: computers, energy and Excluding its home furnishings com- Computer Price Deflation health care. ponent, core inflation barely deceler- Accelerates … Between 1993 and early 1994, infla- ated in 1996. Year-over-year percent change tion fell, according to both the con- Thus, the pickup in overall infla- 0 sumer price index (CPI) and the core tion and the decline in core inflation –5 CPI, which excludes food and energy during 1996 largely reflect the two ex- –10 prices (top panel, Chart 1 ). The overall tremes of an acceleration of energy –15 CPI has drifted upward since early 1994, price inflation (overall) and an accel- –20 picking up from mid-1994 to mid-1995, eration of computer price deflation –25 slowing in late 1995 and then picking (core). This pattern suggests that iso- 1993 1994 1995 1996 up again in 1996. In contrast, core CPI lated price developments may be dis- NOTE: Prices based on the producer price index for the inflation was stable over 1994 –95 be- torting the inflation picture. One way to computer electronic category. fore slowing in 1996. A comparison of filter out the disproportionate influence … Driving Down the upper and lower panels of Chart 1 of unusual price factors is to measure Home Furnishings Prices suggests that most of the wiggles in the inflation by excluding the highest 10 Year-over-year percent change overall CPI reflect swings in consumer percent inflation components (by ex- 3 energy prices. On the surface, the slow- penditure weights) and the lowest 10 2 ing of core inflation last year seems percent inflation components.5 This puzzling in the face of rising energy “trimmed mean” CPI measure (Chart 3) 1 prices, which had tended to bolster shows an upward drift in inflation since 0 4 core inflation in the past. However, in- late 1995 — consistent with the view –1 novations in both health care delivery that the economy has been operating at 1993 1994 1995 1996 and computers have played an impor- levels of the unemployment rate pre- SOURCE: Bureau of Labor Statistics. tant role in holding down core inflation. viously associated with rising inflation.6 Page 2 Southwest Economy March/April 1997 Chart 3 and, within this sector, is less focused wane over 1997–98 if some analysts are Filtering Reveals a Modest on computer chip production. correct in predicting that microproces- Pickup in U.S. Inflation In contrast to computer prices, en- sors are nearing the end of the current Year-over-year percent change ergy prices rose in 1996, reflecting a wave of innovation, as suggested by 3 sudden weather-related rise in demand the slower pace of microprocessor price Trimmed mean coupled with low inventories. This deflation since early 1996. Perhaps for 2.8 consumer price index price rise spurred the oil industry to similar reasons, prices for integrated expand exploration and hiring.11 In circuits—another key computer com- 2.6 addition, new exploration technology ponent—have declined at a slower pace made it more profitable to search for since spring 1996. 2.4 oil under waters where an ocean- Nevertheless, computer price defla- 2.2 bottom salt layer had previously tion actually picked up to more typical obscured reserves— especially true of levels last year, as reflected in the GDP 2 1993 1994 1995 1996 the Gulf of Mexico. Both high energy chain-weight price index for computers SOURCES: Bureau of Labor Statistics; author’s calculations. prices and a technological innovation and peripheral equipment investment favoring oil exploration in local waters (lower panel, Chart 5 ). This index ex- have boosted drilling in the gulf and cludes typewriters and noncomputer energy employment in the Eleventh equipment, whose share of GDP’s capacity outstripped demand. The tem- District’s states (middle panel, Chart 4 ). broader “information-processing and porary imbalance between production Increased worldwide demand for drill- related equipment” component of busi- and orders was reflected in a decline in ing equipment has also bolstered manu- the domestic book-to-bill ratio to levels facturing employment in areas such as below 1, generally indicating that do- Houston. Chart 4 mestic shipments exceeded orders.9 Finally, the restructuring of health District High-Tech Overproduction and overexpansion of care has slowed job growth in that sec- Manufacturing Jobs Reflect Semiconductor capacity led to a buildup of inventories tor, despite the continued increasing Industry’s Fortunes and an unexpected drop in memory demand for health care associated with chip prices, which in turn slowed job a general aging of the population. Year-over-year percent change Book-to-bill ratio growth in the overall high-tech manu- Health care restructuring likely con- 8 1.2 facturing industry in District states. tributed to a recent slowing of the pace 6 1.1 This deceleration in high-tech job at which the share of private health care 4 1 High-tech Book-to-bill growth helps explain why nonfarm job employees in the District’s three states 2 job growth ratio .9 growth in Texas slowed toward the U.S. has risen (lower panel, Chart 4 ).12 0 .8 –2 .7 average in 1996, after several years in 1993 1994 1995 1996 which it substantially exceeded the Oil Drilling and District national average. As demonstrated by The Outlook for Computers, Energy Jobs Recover two Dallas Fed researchers, the high- tech sector—which includes high-tech Energy and Health Care Year-over-year percent change Number 2 320 manufacturing along with communica- District energy job growth 300 tions and computer-related services— Computers. Some analysts attribute 0 280 was a major contributor to Texas job last year’s speedup in computer price –2 growth over 1988 –94.10 Roughly half of deflation to two factors that reduced Texas 260 –4 rig count the broadly defined high-tech jobs in prices for semiconductors (memory and 240 –6 220 Texas are in the Dallas–Fort Worth metro- microprocessor chips), which are im- 1993 1994 1995 1996 plex, where there is a high concentra- portant computer components.
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