The Goldilocks Economy

July 07, 1995

The Federal Reserve Board is mandated by law to produce a Goldilocks economy. It can neither be too hot (inflation) nor too cold (recession) but just right. Every central banker knows, however, that so perfect a porridge comes along only rarely and is often the result of forces far greater than the financial gurus in charge of monetary policy.

By definition, the business cycle is a fluctuating phenomenon -- not a steady-state creation that can hold the temperature of its porridge at close to just right over an extended period. Politics and psychology alone are enough to scramble the most precise of economic models. Add to that an almost infinite number of variables affecting growth or retraction at any one moment and you have a situation best interpreted by intuition and wet fingers held tentatively aloft.

Now that the Fed has reversed course, lowering the short-term federal funds rate by a quarter-point after doubling it from 3 to 6 percent since February 1994, chairman Alan Greenspan has signaled that his recent warnings of a mild recession in the making were not just idle chatter. His words rarely are. He and his colleagues on the Federal Open Market Committee have watched quarterly growth nose-dive from a hot 5 percent in the last three months of 1994 to near zero in the period just ended on June 30. And they have obviously concluded that the dangers inflation are much less than what would be the impact on the markets and consumer confidence if they did nothing.

Yesterday's very modest quarter-point drop in the Fed funds rate -- the rate banks charge one another for overnight loans -- is an astute adjustment. A larger cut was championed in many financial circles. But the Fed rightly concluded that it had to guard against a further weakening of the dollar or adverse trends in the huge daily flow of capital across international borders. Consequently, it held firm on the discount rate -- the rate it charges member banks -- in the knowledge that this rate is

closely watched abroad.

Despite a recent rash of bad news on employment, retail sales and business inventories, 62 economists empaneled by the Wall Street Journal have come up with a consensus view that there will be a rebound in the second half of this year. Especially encouraging is a drop in long-term interest rates affecting mortgages and the vital housing market. Mr. Greenspan predicted such a trend in long-term rates when he first increased short-term rates. Confirmation is now coming in.

This newspaper has unstintingly supported Mr. Greenspan's controversial decisions to boost short-term rates over the past 16 months in the face of complaints by Sen. Paul S. Sarbanes and other liberals that he was short-circuiting the economy. As it happened, the Fed's moves did no such thing. The economy has performed as close to the Goldilocks ideal as anyone could hope: steady growth, low inflation and rising confidence. The new change in tactics deserves similar support.

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