Final sales or demand growth appears to be 5.0 percent or slightly above, while output growth will again be about 4.0 percent. Final sales growth last rose at an annual rate above 4.0 percent for two consecutive quarters while exceeding output growth during the first half of 1988. Interestingly, the same phenomena occurred during the second and third quarters of 1987. In February 1988, the Fed, having briefly reduced the federal funds rate to 6.5 percent after the October 1987 stock market crash, began increasing the rate in the face of strong employment trends that were followed by strong inflation trends. Producers will need to hold production high for several quarters to restore inventories depleted by the recent surge in demand growth.
Inflation is a lagging indicator that results when demand growth exceeds supply growth.
And, during a period when demand growth exceeds supply growth and supply growth is sufficient at over 4.0 percent to push up wages, the inflation potential rises considerably, even though actual inflation may not appear simultaneously with the generation of inflation potential. This potential was clearly what Alan Greenspan and the Fed had in mind by citing the acceleration in demand growth and its attendant inflation potential in the statement announcing the initial 25 basis point increase in the federal funds rate on March 25. Further evidence of incipient inflation lies with the extremely low level of the inventory-sales ratios. Producers will need to hold production high for several quarters to restore inventories depleted by the recent surge in demand growth. An unwarranted chorus of criticism about the Fed's rate increase manifests a confusion between the effects of demand and supply The Fed's concern about inflation is legitimate and soundly based on historical precedent.