Productivity and deflation go hand-in-hand. Thankfully, Alan Greenspan knows this, and he's doing the right thing.
In various speeches and congressional appearances, the Fed chairman has shown that he recognizes that companies have "no pricing power." The Fed chairman may be watching the continuous declines in the producer price index, which at last reading was at 2 percent below last year's level. And he is surely signaling a continued concern with the lingering effects of price deflation. Accordingly, with this deflation in mind, the Maestro is telling us that the Fed has no intention of raising the key Fed funds rate in the foreseeable future.
Greenspan may also (correctly) be charting commodity prices. The Commodity Research Bureau spot index, which is down 32 percent since the 1996 peak, contains 22 commodities -- including key business raw materials such as copper, lead and steel scrap, as well as tin and zinc. The index tried to mount a late-winter rally, but since March it has rolled over and headed back down. Thumbing through several of the CRB sub-indexes, the best that can be said is that some commodities are showing stability after several years of deflation. However, a couple of the indexes -- notably textiles, foodstuffs, livestock, and fats and oils -- are still deflating.
Corporate pricing power would be on full display if these commodities were rallying. But they are not. Even if they jumped 10 percent or 15 percent from severely depressed levels, that would be OK in the view of the predominant deflationary pattern of recent years. Certainly the central bank would not want to overreact by keeping fresh money out of the market in a period of commodity stability. Fortunately, Greenspan appears to be on the same page.
Productivity, the miraculous economic tonic that appears to be the backbone of the nascent recovery cycle, is the other key indicator that Greenspan's watching. But it's a double-edged sword. On the one hand, rising output-per-hour creates time-saving, labor-saving and cost-reducing patterns that will promote better investment returns, higher profits and stronger economic growth.
But productivity stemming from technology advances and applications, such as we are presently experiencing, also creates inexorably downward price pressures. Technology breakthroughs make it a lot cheaper to produce commodities, finished goods and all manner of services. These cost reductions, or at least some of them, are passed on in the form of lower prices. Technology shocks are like supply-side tax cuts: They cut costs, restrain prices and promote stronger growth.
The Fed is mindful of the price-falling effects of productivity and the actual weakness of various commodity price indicators in the open market. These are two very positive occurrences. They both mean that the central bank will keep providing plenty of new cash to support the early recovery economy during a period when the last vestiges of deflation and credit crunch are still observable.
Is the Fed chairman back on a price rule to guide Fed policy? No one can be sure. But his recent comments and the Fed's lack of new restraining actions are very positive signals.