Inflation: the rules have changed.

• Author: Marn, Michael

Business reality will continue to keep prices in check, regardless of where the Fed chooses to take interest rates.

The U.S. economy continues to thrive, and inflation is not raging out of control. Producer prices are rising at an annual rate of less than two percent; consumer prices less than three percent. Federal Reserve actions have been credited widely with keeping inflation in check. However, forces much more powerful than Fed interest rate manipulation have come into play in recent years and deserve the real credit for keeping the lid on price increases.

Sharp price jumps have accompanied prior economic recoveries. Suppliers historically used recovery-driven inflation as cover for "passing through" cost increases (plus a little additional) to customers in the form of higher prices. These excessive raises widened profit margins for the suppliers while, of course, further exacerbating inflation.

The days of price inflation being the natural bedfellow of economic growth and recovery may be over, though. A fundamental revolution in how we buy and sell has occurred since the recovery of the early 1980s--both in consumer and industrial markets--that will hold down prices, independent of where the Fed takes short-term interest rates. The roots of this revolution are deep and powerful and include:

Graying boomers. The "middle-aging" of the baby boomers is a potent driver of change in consumer demand. Since 1985, some 33,000,000 baby boomers have entered their 40s and have begun to rein in their expensive spending habits from the 1980s. This is a result of their having been hit squarely between the eyes with the economic realities of needing to pay for the education of their children, help longer-lived parents in their retirement years, and save for their own retirement. With another 25,000,000 boomers poised to reach their 40th birthdays before the end of the decade and with gains in average household incomes expected to be modest at best, this trend toward more conservative spending is likely to expand and restrain consumer price increases.

Frugal "Generation Xers." The generations behind the baby boomers are showing little of the conspicuous consumption behavior that boomers displayed--and that fueled consumer price inflation--in the "go-go '80s." Having grown up with plenty of exposure to discount retailing and being less confident about job security and future earnings potential, this group unabashedly seeks out bargains and values. To...