Another from the editorial page of WSJ:
--------------
June 15, 1999
--------------------------------------------------------------------------------
Review & Outlook
The Fed's Curio Closet
The U.S. economy is thriving. Creativity and new technologies abound, people are working in record numbers and even the battered world economy shows signs of pulling out of crisis. This is all good news. But the mood now could hardly be called exuberant. Everyone is worrying about inflation.
Or, would it be more accurate to say that everyone is worrying about the Fed worrying about inflation?
This distinction matters, because there are signs the Federal Reserve is worrying about inflation for the wrong reasons. While modern markets keep trying to move on to the 21st century, the Fed won't let go of such hand-cranked notions as the Phillips curve, or NAIRU, the non-accelerating inflation rate of unemployment--a concept as dense as its name.
These models ply the idea that there is a tradeoff between unemployment and inflation: that you can have fast growth, or you can have low inflation, but you can't have both at once. So to fight inflation, stamp out growth. Or at least stamp out "overheating"--whatever that may mean.
This is nonsense. Good growth with low inflation is exactly what this country has been enjoying for years now. During the late 1970s and early 1980s, this country had high inflation and low growth--the very opposite of what the Phillips curve would imagine. Over the past 20 years, the Phillips curve has failed completely to serve as a model with any predictive power.
Phillips-curve economics never made much sense, even in the days when it seemed to coincide somewhat better with reality. Inflation is a matter of price level, and depends on the supply of money (and the demand for it, which confounds simple-minded monetarism). So, you might think the Fed would shelve the Phillips curve in some library of quaint but useless curiosities, maybe next to the flat-earth exhibit. Nope. As one senior Wall Street banker notes, some of these folks grew up with the Phillips curve implanted in their brains.
Fear of too much growth was the basic reason for the Fed's warning last month that its policy had "tilted" toward fear of inflation. Tighter money might soon be called for, said a Fed press release: "against the background of already tight domestic labor markets and ongoing strength in demand in excess of productivity gains." (Translation: Lots of Americans are employed, and we'd better soon put a stop to that.)
It makes sense, of course, to be alert to real signs of inflation--which disrupts commerce and costs the economy. Certainly the Fed needs guideposts in deciding how fast to create money. The place to look, however, is not the Fed's curio closet, but the market itself. Folks with real money on the line every day have lots of incentive to pay attention not to Phillips-whatevers, but to real life, and their judgments will be reflected in the prices they pay to clear the market.
There, the signals on inflation are mixed. As the nearby charts show, the Consumer Price Index rose noticeably last month. Much of that change appears to have been a one-time rise in the price of oil. And as a measure of price level, the CPI itself falls well short of telling us what's actually happening in the way of quality of life and productivity in this country, where the hard-to-quantify service industries increasingly dominate. Certainly the May CPI number, due out Wednesday, bears watching. But nothing here so far warrants panic.
On the contrary, the price of gold has been hitting record lows, suggesting not inflation, but deflation. With the exception of oil, where the price has been driven up by OPEC production curbs, other commodity prices have also been weak. And the dollar, despite some bad days recently, remains high relative to other major currencies this decade. Falling commodities and high foreign exchange rates are signs of tight money, not easy money.
In quest of other inflation indicators that start to steer clear of Phillips-thinking, one intriguing measure involves some of the relatively new inflation-indexed bonds that Treasury began issuing last year. As Fed Chairman Alan Greenspan has repeatedly observed, the spread between yields of these inflation-indexed bonds and fixed-rate Treasurys offers a theoretical measure of what the market expects in the way of inflation. To the extent this is a valid indicator, it does suggest an inflation uptick; see nearby chart, where the shaded area indicates the spread. Back in early October of 1998, the difference in yield between inflation-indexed and fixed-rate, 30-year bonds reached a low of only about 1.29%--suggesting expected inflation of 1.29%. Since then, this spread showing expected inflation has widened to 2.38%.
As indicators, though, even these bonds come with caveats, as Chairman Greenspan keeps noting. For one, the flexible-rate bonds are indexed to the CPI, itself a faulty measure. Also, given limited experience with this measure, we're not sure to what extent the spread may include market expectations of what the Fed might do next. It was also at about this level a year ago, when there was a lot of talk about a NAIRU-induced rate increase. When the Fed began signaling it would instead cut rates, and then did so because of the international economic crisis, the spread fell.
The rationale for Fed policy matters a great deal. If it seems justified by tomorrow's price announcement and related to actual market prices, an interest rate boost would not reverse economic growth or roil markets. But if the Fed is getting on the NAIRU bandwagon, making growth itself the enemy, we would be in for a series of tightenings until we get the recession this perverse ideology demands.
|
