Is Inflation Really Dead?

I have a theory that inflation is not quite as dead as it seems, and now is as good a time as any to explain it. Just last week, the Federal Reserve declined to increase short-term interest rates - the standard weapon against rising inflation - because inflation doesn't, in fact, seem to be rising. For the year ended in April, the consumer price index was up a scant 2.5 percent. That was less than the increase for 1996 (3.3 percent) and identical with the 1995 increase.

At this stage of the business cycle, almost everyone expects inflation to intensify. Remember, we're now in the seventh year of an economic expansion that began in April 1991. Unemployment is low, creating (it's assumed) upward pressure on wages. Consumer confidence and demand are high, giving companies (it's assumed) leeway to raise prices and preserve profit margins. What do we actually see? Well, labor costs are edging up, but so far they haven't - by government statistics - reduced profits or raised inflation.

The conventional explanation for this is that companies, facing more competition, simply can't raise prices. So they've improved efficiency ("productivity") to absorb higher wage costs. "It's almost impossible for manufacturers to get price increases in the current environment," says Jerry Jasinowski, president of the National Association of Manufacturers. In a front-page article last week, The Wall Street Journal echoed the same theme. It cited Burger King, which has raised starting pay (to $7.50 an hour in some stores, up $1 from a year ago) but has trimmed costs by taking 30 items off its menu. This enables workers to handle more meals.

Up to a point, I agree. The heightened pressures on individual companies - including demands from Wall Street for bigger profits - have stabilized the economy by encouraging efficiency and dampening inflationary behavior. Still, the explanation seems just a bit too pat, the picture of beaten inflation just a bit too convenient. The reason that I suspect there's more inflation is a change in the way companies price their products. In a word: discounts. They mushroomed in the 1980s and 1990s, but most are missed by government price statistics. As a result, price statistics may not catch small swings (up or down) in inflation.

For consumers, the discounts include frequent-flier miles, coupons, special promotions (example: a photo store that, once a week, offers two sets of prints for the price of one) and credit-card rebates (example: a food chain or a car company that discounts prices for its cardholders). For businesses, the discounts involve negotiated concessions off listed prices. NEWSWEEK, for example, has an official advertising "rate card." It prices a four-color, full-page ad at $148,800. But as with other magazines, many advertisers (perhaps most) successfully bargain for lower prices. My brother runs a small inn in Cape May, N.J. He tells me that more customers now demand discounts. The Wall Street Journal recently reported that parents of college students increasingly seek tuition discounts.

The inability of the CPI and other price indexes to capture many of these discounts is one reason why they generally overstate inflation. (The CPI mostly follows standard prices, which change less often.) But in a strong economy, companies may quietly trim discounts - that is, increase prices. Then the price statistics will miss rising inflation. In the past few years, I think, precisely this has happened.

That's the theory. Is there any evidence for it? Well, some common discounts are diminishing. Consider:

Frequent-flier miles: In 1996 the number of frequent-flier tickets awarded by 10 major airlines dropped 7.7 percent, reports InsideFlyer magazine, which covers airline and hotel discount programs. By contrast, frequent-flier tickets rose 27 percent in 1993, 14 percent in 1994 and 9 percent in 1995. Airlines curbed these awards by raising the number of miles needed to qualify for a "free" ticket (from 20,000 to 25,000) and reducing the seats on some flights available for frequent-flier tickets.

Shopping coupons: In 1996 the face value of the average shopping coupon for grocery and beauty-aid products dropped for the first time since 1980 (from 68 to 66 cents), reports the market-research firm NCH Promotional Services. The volume of new coupons also decreased; it declined 6 percent in 1995 and 8 percent in 1996.

Supermarket prices: A study by ACNielsen of 100 common packaged grocery products (cereals, soups, soft drinks, paper towels) found that the actual prices paid by shoppers increased much less than the CPI for food in 1993 and 1994; the implication is that coupons and promotions trimmed food-price inflation. But in 1995 and 1996 the trend reversed, suggesting lower discounts. In 1995 prices rose at about the same rate as the CPI; and in 1996 the increase exceeded the CPI. (The study used computer tapes from cash registers to see what customers actually paid for items.)

If there were good information on business-to-business pricing, I think we'd also see less discounting. Companies began emphasizing discounts in the 1980s, because inflation subsided. (In 1979 the CPI rose 13.3 percent; in 1984, only 3.9 percent.) With high inflation, price competition could occur if one company raised prices less than rivals (say, 4 percent instead of 6). When general price increases became less frequent, companies devised new methods of competition. American Airlines invented frequent-flier miles in 1981. The volume of shopping coupons increased more than twice as much in the 1980s as in the 1970s. Magazines started to discount ad rates in the mid-1980s.

How important is this? I don't know. Some discounts may now be increasing, offsetting those that are declining. Even without that, the impact wouldn't be huge. My hunch is that if government could measure the impact of discounts, it might now raise annual inflation 0.1 to 0.3 percent. After all, people don't buy most groceries with coupons or make most trips with frequent-flier tickets. The better information might (or might not) have affected how the Federal Reserve acted last week. But it does suggest that the urge to raise prices hasn't disappeared and that, given the opportunity, businesses will do it.