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Wall Street's inflation fears excessive, some experts say

Published Oct. 6, 2005

Seized by renewed fears of inflation, investors have pounded stock and bond prices lower and interest rates up.

But some economists say inflation, while universally dreaded on Wall Street, is not always a reason for fear. Small doses of inflation may be the price of an economic recovery and in some cases might actually be helpful.

"Inflation is a mixed bag," said Dean Baker, an economist at the Economic Policy Institute, a Washington research firm. "There are winners and losers of inflation. It's by no means altogether a bad thing, and in some ways it's a good thing."

Inflation is currently running at about 2.5 percent per year, the Bureau of Labor Statistics says. That means whatever costs $1 now will cost $1.02{ next year, and isn't much reason for concern.

But many Wall Street economists watch other measures, such as indexes of commodity prices. The Commodity Research Bureau index, for example, which tracks the price of raw materials such as oil and wood, grew 11.6 percent in 1993, the first yearly increase in six years.

Business executives and Wall Street investors remember the 1970s and early 1980s, when annual double-digit inflation wreaked havoc on balance sheets. They are so afraid of a replay that they leap into action at the barest whiff of higher prices.

"There's this saying on Wall Street that a little inflation is like being a little pregnant _ you can't be," said Richard Belous, chief economist with the National Planning Association, a Washington research group funded by business and labor.

Many concerns about inflation are justified. It makes financial planning difficult, both for businesses and households. It drives down the value of long-term, fixed-rate investments. This not only makes bond investors unhappy, it also erodes the value of retirement nest eggs and college funds.

In many industries, wage increases do not keep pace with inflation. Most labor contracts no longer include cost-of-living adjustment clauses as they did in the 1970s. So for many people, inflation has the effect of lowering real wages.

High inflation also encourages investment in unproductive ventures such as real estate speculation, said David Orr, chief economist at First Union National Bank in Charlotte, N.C.

But some parts of the economy benefit from rising prices. In times of inflation, borrowers of fixed-income debt pay back their loans with money that is worth less.

Inflation raises the value of homes and real estate, which are the main assets for many families. Average prices of existing homes edged up in January to $134,200 from $133,700 in December, and up from $129,200 in January 1993, according to the National Association of Home Builders.

As short-term interest rates go up, investors in money-market funds and certificates of deposits can benefit. Last month saw the first concerted increase in savings rates in five years, according to Bank Rate Monitor, an industry newsletter.

Current inflation rates are not a problem, Belous said. But if inflation rises fast and high enough, it will force interest rates much higher and could choke off corporate investment.

Huge job cutbacks have made the labor market so glutted that workers cannot demand and win large wage increases, and competition with lower-paid workers overseas is also capping wages, Belous said.

The bond and stock markets will continue to react violently to suggestions of inflation, the analysts said. That could serve the useful purpose of acting to raise interest rates before the Federal Reserve is forced to do it.

But such volatile reactions are not warranted by the data, at least not yet, Orr said. "Ultimately it will prove to have been overblown."