Inflation is back, and expect the Fed to hit harder than usual. The consensus for a 25 basis point hike in May is evaporating with the latest CPI/PPI numbers. I was definitely wrong about a recession in 2000, but throwing the brakes on an overheating economy is a ticklish business. I imagine we'll see a weakening economy by 4Q 2000... and I doubt this will be the last rate hike we'll see this year.

-- Ken Decker (kcdecker@worldnet.att.net), April 30, 2000

Answers

Ken, you're an economist, right? This is totally off-topic, but can you explain the difference between nominal VS real income in terms a layperson might understand?

-- (Adelle@home.now), May 01, 2000.

Alright! A chance to use some of my college econ courses.

The idea of real vs nominal income is really pretty simple. The formula is:

Real income = Nominal income - inflation rate

where nominal income is your gross pay before deductions. Let's say that you got a five percent raise and the inflation rate as measured by the CPI is three percent. Your real income just increased by two percent. If it was the opposite (three percent raise and five percent increase in inflation) your reeal income just went down by two percent.

The average person already knows that this disparity exists without know anything about the terms. In general, the higher the rates of inflation, the more wages have to increase to have real income match nominal income in purchasing power. At some point, this perception is such that demands for wage increases will exceed the inflation rate and that's when things get dicey.

-- Jim Cooke (JJCooke@yahoo.com), May 01, 2000.

Did you predict a recession and now you think there will not be one? We still have 8 months left, and I think we will have a recession.

-- Hawk (flyin@high.again), May 01, 2000.

Jim, thanks. I was listening to a group of college students discuss this today, and they were throwing in all kinds of things, like tax rates and appreciation. It didn't make much sense to me, but your explanation does.

-- (Adelle@home.now), May 01, 2000.

Nice job, Jim....

Adelle, I am not a practicing economist. I worked in applied microeconomics for a few years. It's interesting to run simulations and models, but I really prefer the real world.

Real income can refer to an individual, organization, or country. You may have overheard students talking about national nominal income rather than "real wages." Economists have lots of ways to measure aggregate income. As Jim suggests, the word "real" indiciates the income in question has been adjusted for inflation. "Disposable" indicates income minus personal taxes.

Most folks worry about personal income, not income in the aggregate. The key point is one almost everyone realizes. Inflation (the general increase in prices) reduces purchasing power. If wages do not rise at the rate of inflation, you are actually moving backwards!

Hawk, I predicted a recession starting in 2Q/3Q... and it doesn't look like the economic will dive during the next two quarters. Mea culpa.

-- Ken Decker (kcdecker@worldnet.att.net), May 01, 2000.

About the 50 bp rate hike: I fully agree that we are in for more rate hikes, and that they will exceed 50 bp total from where we are now. Perhaps another 75 bp by Aug 1.

But one thing that is certain about Alan Greenspan is that he doesn't like to upset markets and he just loves to use 25 bp incements. A 50 bp hike would enough out of character that I wonder if we'll ever see one from the Greenspan Fed again. He may seek approval for 50 bp from the Fed Board, but split the 50 into two 25 bp hikes spaced about 3-4 weeks apart. He's a creeper, not a jumper.

-- Brian McLaughlin (brianm@ims.com), May 01, 2000.

Brian -

Dr. Greenspan has always been a serious inflation hawk. The Fed used 50 bp rate hikes successfully in 1994-95 to slow things down and create a "soft landing", and they'll do it again if they see the need.

In case you're interested, here's some minor hand-wringing from Time magazine (Nov 1994), while the Fed was doing its thing: GREENSPAN'S RATES OF WRATH

...The outlook could be darker by then, particularly if the Fed continues to heed the bond market and pushes rates still higher. According to David Blitzer, chief economist of Standard & Poors Corp., there have been nine U.S. recessions since World War II but only two soft landings. In effect, the odds are 9 to 2 against the Fed in 1995.

We now know that they succeeded, even against those odds. Here's hoping they can manage it again.

-- DeeEmBee (macbeth1@pacbell.net), May 01, 2000.

OK, I'm dumb. What's a basis point, why do the numbers of basis points matter, and what does that have to do with inflation?

-- helen (home@the.farm), May 01, 2000.

Helen:

Don't you love all the economic code words? :^)

A basis point is one-hundreth of a percent, so 25 basis points is .25% or one-quarter of one percent. Raising the interest rate by .25% or .50% makes it more expensive to borrow money. Since most corporations live on borrowed money, this means their expenses will go up and, hence, prices with them.

-- Jim Cooke (JJCooke@yahoo.com), May 02, 2000.

Thanks Jim. :)

-- helen (home@the.farm), May 02, 2000.

Jim said: Let's say that you got a five percent raise and the inflation rate as measured by the CPI is three percent. Your real income just increased by two percent.

Let's compute this more carefully. Say your income was 100. After the 5% increase it is 105. But due to inflation it takes 103 to buy what 100 used to buy. So divide 105 by 103 and get 1.0194... which is what your buying power has been multiplied by. This is a 1.94% increase rather than 2%.

dandelion

-- dandelion (golden@pleurisy.plant), May 03, 2000.

More bad news today on the inflation front:

Nifty Fifty? After Beige Book, the Bond Market Sure Thinks So!

By David A. Gaffen (The Street.com Staff Reporter)

5/3/00 3:55 PM ET

The bond market sold off sharply this afternoon after a quiet morning, as the Federal Reserve's anecdotal economic survey, the Beige Book, reported rising wage pressures and price pressures.

The report supports the growing sentiment that the Fed could increase the Fed funds rate by 50 basis points at its May 16 meeting, and that hurt the market this afternoon across the Treasury yield curve.

Lately, the benchmark 10-year Treasury was down 22/32 to 100 23/32, boosting the yield 9.3 basis points to 6.398%. The two-year note was down 2/32 to 99 11/32, yielding 6.732%.

"The afternoon selloff caught a lot of people off guard," said Mike Franzese, intermediate government trader at Zions First National Bank in Jersey City, N.J. "Nobody wanted to believe" that costs were increasing.

The market weakened after the 2 p.m. EDT release of the Beige Book, an anecdotal survey of nationwide economic conditions that comes out generally a few weeks before a Fed meeting. This report said that "there were more frequent reports of intensifying wage pressures as shortages of workers persisted in all Districts," the Beige Book said. "Increasing input prices were noted in nearly every region."

That wording is a bit more grave than previous Beige Books, which told of wage pressures and tight labor markets, and after last week's Employment Cost Index shocked the bond market, traders have been on guard.

"The problem is, this report reinforces the fears that grew out of the ECI," said Tony Crescenzi, chief bond market strategist at Miller Tabak. "Wage and cost inflation pressures are in the system now..."

-- DeeEmBee (macbeth1@pacbell.net), May 03, 2000.