Fed walks a tightrope

Rate increase: Central bankers want to pre-empt inflation first, worry about current expansion later.

August 27, 1999

BY RAISING interest rates for the second time in eight weeks, the Federal Reserve has made a clear statement that preventing any emergence of inflation is a paramount policy goal. Maintaining the nine-year economic expansion, while important, is a secondary consideration.

Even though the government's own figures show benign levels of inflation, Fed Chairman Alan Greenspan and his colleagues seem preoccupied with rising prices.

Some economists, however, believe we have entered a new era of noninflationary growth. A strong dollar, excessive global industrial capacity, a leveling of health care costs in recent years, worldwide agricultural surpluses and steady productivity increases have blunted any inflationary price increases, at least so far.

Mr. Greenspan seems worried that these factors are transitory and that traditional economic dynamics will take hold. Already, labor shortages are cropping up across the country. Wages are beginning to rise for the first time in years. Big increases in health-care costs have resumed. Industrial capacity is rising to record levels. Energy prices have increased more than 24 percent so far this year.

In previous recoveries, these were ingredients for inflationary price increases. Mr. Greenspan and the Fed board are unwilling to take any chances. They don't want these negative forces to form a critical mass capable of reigniting inflation.

Interest rates are still slightly lower than the levels of November 1998, before the Fed slashed them in response to the Asian financial crisis. The U.S. economy was vigorous then, and Mr. Greenspan is betting his current efforts won't short-circuit the nation's historic economic recovery.

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