Economy on the Upbeat

October 03, 1994

America's economy as 1994's fourth quarter begins is robust despite five modest increases this year in short-term interest rates. All year long, liberal Democrats have been complaining that the Federal Reserve Board's actions in stepping up short-term rates would short-circuit the recovery. Well, it hasn't happened.

In August, sales of new single family homes jumped 9.7 percent -- thus indicating once again that so long as 30-year mortgages stay under the 9 percent level the housing industry can flourish. Personal income and spending for the same month were stronger than anticipated. Gross domestic product is running at a solid 3 percent rate for the year. Manufacturing output, especially in autos, continues to rise. Unemployment is down. So is the number of people filing for jobless benefits.

Congressional passage of a new interstate banking bill and anticipated approval of a far-reaching reform of world trading rules after November elections should provide further boosts for the economy. Even on the global scene, the International Monetary Fund reports that industrial nations are having their best year since 1987, with average growth of 2.7 percent, while developing countries pull up the world average to more than 3 percent.

If there is one overriding threat in this happy scenario it is inflation, this despite repeated assertions by Fed critics that it is under control and higher interest rates are unjustified. What is striking is that the financial markets don't accept this reasoning. While Fed chairman Alan Greenspan defends and Maryland Sen. Paul S. Sarbanes attacks the incremental short-term rate boosts of the past nine months, long-term bond yields keep inching up. Why so? Because elements in the business community that worry about the far-out future rather than the next quarterly earnings report continue to fear a return of high inflation. They believe that if Mr. Greenspan has erred, it has been on the side of being too accommodative rather than too severe.

In this situation, Fed policy represents a sound middle way that deserves a lot more support than it gets. If the Fed orders a sixth boost in short-term rates, it will be because inflationary pressures are too distinct to be ignored by those with responsibility for maintaining a long, steady recovery.

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