Fed plan seems to work, but does economy need it?

SUNDAY OUTLOOK

June 26, 1994|By Patricia Horn

Last week, Federal Reserve Chairman Alan Greenspan pronounced the U.S. economy strong. "Economic activity has strengthened, unemployment is down, and price trends have remained subdued," he told the House Budget Committee.

Over the past several months, the Fed has raised short-term rates several times to slow the economy and control inflation. But is the plan working, or has it slowed the economy too much?

Ralph Monaco

Economist, University of Maryland

The Federal Reserve has about the right take on the economy. Short-term rates are probably just a little too high. But that is a small quibble.

The Fed does seem to be awfully afraid of an inflation that has not only not yet appeared, but whose warning signs have not yet appeared. There has been some kick up in raw materials prices, but that is not a very good early indicator. A better indicator is wages. At this point, we are not seeing major increases in wages.

The Fed is trying to be conservative, saying we need to be doing something now to avoid inflation down the line. The proof of whether that strategy is any good is not next week or next month, but the middle of next year.

The economy is doing fairly well. In some senses, I'd say relax and be happy. The unemployment rate is down. There was real growth in the second quarter. For the first half of the year, we'll see 2.5 percent to 3 percent real growth, a decent number. Inflation is under control. I don't see any looming problem with inflation over the next six months and maybe the next year.

Dean Baker

Economist, Economic Policy Institute

I think there is a lot of evidence that the economy has slowed fairly quickly. Retail sales are slowing fairly quickly, and there is not much evidence they are bouncing back in June. Clearly the housing market is slowing down and car sales are slowing.

The fourth quarter was a statistical aberration. The economy was never growing that fast. I think the economy is slowing faster than the Fed thinks. We are likely to see very modest growth, in the 2.5 percent ballpark. In terms of what most people care about, that is not likely to enhance job security or raise real wages.

The fact is there is almost no evidence of inflation anyway. I would be surprised if the Fed raised interest rates significantly for the next six months. Unions are clearly an awful lot weaker, temporary employment is increasing, so workers will not be able to push up wages any time soon.

Carl Christ

Economist, The Johns Hopkins University

The thing the public should understand -- and a lot of people don't -- is that the Federal Reserve's most important power is affecting inflation. The Fed can affect employment and interest rates in the short run, but in the long run it cannot. It is really a mistake to try to fine tune the economy in the short run.

Greenspan is walking a tightrope because so many people think that the Fed can fine tune the economy. The Federal Reserve's major mistake in the last 20 years was in trying too hard to counter recessions and keep interest rates from rising. It really doesn't have the power to do that.

I would say that whether the economy is slowing too much is not the Fed's business. It should not worry very much about interest rates. It should follow a policy of steadily but slowly increasing the monetary base and make sure that we do not get into an inflation. Greenspan should be encouraged to do pretty much what he has been doing.

David Stevens

Executive Director, Jacob France Center, University of Baltimore

Up to this point, Greenspan has taken the right path. The question is, should we continue to fear inflation without having more compelling evidence?

At the national level, some of our traditional measures are being questioned. As you see the manufacturing capacity level creeping up to historically high levels, does that have the same inflationary consequences as in the past? That measure traditionally thinks of production being under one roof, but the growth of outsourcing and employee leasing has dramatically changed the flexibility and location of production and diminished the pressure on both capital costs and labor costs. Those provide less useful information now. I am not surprised that we have not yet seen the up tick in labor costs and equipment purchases that we might have expected in past post-recession periods.

A couple of ticks in interest rates to get people's attention is fine, but there is no compelling evidence for continued up ticks yet. The fear of that around the corner there must be lurking higher costs has to be seen in the context of a more flexible interplay of producers.

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