Prepared by

The Northern Trust Company

In May, U.S. CPI inflation dropped to 2.2% on a year-over-year basis. Core consumer inflation, on an annual average basis, was just 2.7% in 1996-the lowest since 1966. So, it is altogether fitting that Alan Greenspan and his bride host their annual Fourth of July fireworks party on the roof of the Martin Building, the Federal Reserve Board building named after the last Fed chairman to be at the helm when underlying inflation was as low as it is today. Many of the guests may justifiably laud the current chairman for his genius in bringing about such a low level of inflation. But if Chairman Greenspan is a genius, then Antonio Fazio, the head of the Bank of Italy, would have to be considered some kind of central banking Einstein because the year-over-year Italian CPI in May was even lower that of the U.S.-1.6%. In fact, among the G-7 nations-Canada, France, Germany, Italy, Japan, the UK and the U.S.-only the UK has a higher consumer inflation rate (2.6%) than we do. In the G-7, which accounts for about 71% of world output, consumer inflation ranges from a low of 0.9% in France to the aforementioned 2.6% in the UK.

There are a lot of explanations offered as to why the U.S. inflation rate has been so well behaved in light of the low unemployment rate. Fed Chairman Greenspan's "helmsmanship" is one of them. Others include U.S. corporate restructuring, the payoff from computer technology, the downsizing of the U.S. government, the greater participation of China and former Iron Curtain countries in international trade, the elimination of inflation psychology and demographics. We think all of these explanations have validity to a greater or lesser degree. Some of them, however, are difficult to quantify. But one explanation that receives less ink and is relatively easy to quantify is the one we want to discuss this week-the uncharacteristic weakness of other industrialized economies at this stage of the U.S. business cycle.

As the unemployment rate has been coming down in the current U.S. economic expansion, unemployment rates have been rising considerably in a number of large industrialized countries. The G-7 accounts for 71% of the world's output-27% from the U.S. and 44% from the remaining six countries of Canada (2.1%), Japan (19.1%), France (5.7%), Germany (9.0%), Italy (4.0%) and the UK (4.1%). So, if the G-6 is experiencing anemic growth and rising unemployment rates, then this very significant economic bloc would not be putting heavy demands on global productive resources, thereby tending to hold down global inflation. As we mentioned at the outset, as low as the current U.S. inflation rate is, it is high relative to five of the G-6 countries.

The drop in the U.S. unemployment rate from 7.5% in 1992 to 5.4% in 1996 has been accompanied by a significant rise in the G-6 unemployment from 5.9% to 7.2%. On a percentage basis, the weighted-average G-6 unemployment rate rose a whopping 22.0% as the U.S. unemployment rate came down 28.0%. The G-6 unemployment rate also rose in the 1975-79 period as the U.S. unemployment rate was coming down. But the G-6 unemployment rate rise in this period was exceptionally small absolutely-only 0.4 of a percentage point-and mild by 1992-96 standards on a percent change basis-12.9%. The G-6 unemployment rate was significantly higher in 1996 versus 1989-7.2% versus 5.7%-when the U.S. unemployment rate was almost the same in both periods-5.4% versus 5.3%.

So, when Alan Greenspan receives kudos for the job he has done in holding down U.S. inflation during this economic expansion, we are sure that he will acknowledge some of the help he has received from Antonio Fazio and other G-6 central bankers and finance ministers. Without their policies that have produced the highest unemployment rates and lowest inflation rates in their countries in decades, it all might not have been possible for the U.S. to enjoy such a low unemployment rate along with a low inflation rate. New paradigms notwithstanding, if the G-6 starts to adopt some economic policies to stimulate aggregate demand, Alan may not look like quite the central bank genius he does now.

July 2, 1997Paul L. Kasriel

The Northern Trust Company

50 South LaSalle Street, Chicago, Illinois

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