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Wednesday, Aug. 20, 2008

Inflation’s Bad, But It Could Be Worse

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Although consumer inflation is at a 17-year high, historically high oil prices are not necessarily to blame.

In fact, high oil prices, the economic slowdown and the Chinese work in tandem to keep infla tion from becoming even worse.

July's Consumer Price Index (CPI)- which follows the change in prices for common consumer goods-is worrying, with its 0.8% rise over June, doubling ana lysts' expectations. Year over year, the CPI rose 5.6%, nearing the 6.29% rate set in early 1991. But the higher oil prices don't necessarily lead to widespread inflation.

"We're not officially in a recession, but we are in a slowdown, and that depresses price growth," says Prof. William Holahan, chairman of the economics department at UW-Milwaukee.

While it's easy to blame skyrocketing oil prices, they also create conditions that par tially check inflation. "One plays off against the other," Holahan says. Holahan likens rising energy costs to a tax on consumers. "Higher fuel costs are actually worse than a tax, because when the gov ernment raises taxes to build a road, it takes money from one part of the economy and puts it into another," Holohan says. "At least consumers are getting something for their money that way." But the extra dollar we spend at the pump doesn't add value. "As prices go up inter nationally, money flows out of the country.

And that depresses other parts of our economy," says Holahan. "Businesses and households have to compensate by cutting back their demands on other products."

One Milwaukee market analyst, speaking anonymously, says many businesses would rather see a cut in their profits than pass on higher fuel costs to customers by raising prices on their products. "There has been immense pressure on producers not to pass on higher costs, so that has restrained inflation." Raising prices risks losing cus tomers to competitors who hold the line. But business price restraint comes with its own price-a decline in corporate profits that is reflected in the stock market, where major indexes have fallen precipitously.

"Profit margins have decreased from a year ago because of the higher energy costs," he says. Corporate profits, says the analyst, could edge up if oil and other commodities con tinue their recent decline, especially for com panies that have raised prices.

"If those prices stay down, we should see higher profits in the third and fourth quar ters, because when a business raises its prices, it tries very hard not to lower them," he says. Additionally, the Chinese government's penchant for buying U.S. debt has until recently kept inflation in check by propping up the value of the dollar.

"The Chinese sell us goods and earn dol lars. If they used those dollars to buy American goods, it would be inflationary to the Chinese economy," says Holahan.

"Instead, they buy American assets [our debt] to keep U.S. goods and services out of their country."