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Fed takes a wrong turn

As it has many times in the past, the Federal Reserve Board is taking the country down the wrong road by raising interest rates: It has violated the dictum, "if it ain't broke, don't fix it," and as a consequence, the smooth recovery from recession that has cheered business and consumers over the past year is being threatened.

On Jan. 31, Fed Chairman Alan Greenspan told the Joint Economic Committee in widely-analyzed testimony that the central bank _ which had allowed interest rates to fall to record lows _ would not change policy to slow down economic growth.

But four days later, on Feb. 4, the Fed raised short-term interest rates by one-quarter of a point in a "pre-emptive strike" against future inflation. To make sure that there was no doubt in the markets that the Fed had decided to interrupt the easy-money pattern, Greenspan publicly announced the move.

In new testimony last week, Greenspan failed to justify the Fed's action. He admitted that there was no discernible inflation; that wages are not moving up; that there is virtually no fear that the economy is growing fast enough to make overheating a danger.

Moreover, the chairman admitted that one pre-emptive strike (he called it "low-cost insurance" against an inflationary build-up) might spawn another. If history is any judge, he told a House Banking subcommittee, "real short-term rates are more likely to have to rise than fall from here."

Since a single, one-quarter point increase in rates would clearly have little effect by itself, market experts have been forced to conclude the Fed was taking merely the first step in a series of interest boosts that might leave rates as much as } of a point higher by the end of the year. Else, why do it at all?

Greenspan's testimony last week, before a hostile subcommittee, confirmed the likelihood of that pattern, simultaneously dampening business and consumer confidence: If the Fed is willing to raise rates while NO inflation is evident, the wise men at the Constitution Avenue edifice must be convinced that inflation is definitely somewhere on the nearby horizon.

But ask Greenspan or any governor of the Fed to name a product or service that is in short supply!

Greenspan, on Feb. 4, apparently was betting that he could raise short-term rates without affecting long-term rates. His "low-cost insurance," he hoped, would dampen inflationary expectations, keeping long-term yields low.

To date, the record shows he's wrong: the Fed action perversely convinced markets that an inflationary spiral was inevitable. Long term rates, which reflect inflationary anticipations, rose to about 6.60 percent, then fell back to 6.40 at the end of last week's testimony.

But at one point around the turn of the year, long-term yields had been well under 6 percent _ a circumstance that all agree helped strengthen the economy. The recent budget and economic report were predicated on long-term rates holding at 5.8 percent.

Greenspan should have waited until inflation was a reality before firing the first shot. But it is traditional for chairmen of the Fed to be spooked by inflationary expectations.

To be sure, there are those reading tea leaves who have managed to find a threat of inflation in reports from businessmen and purchasing agents who expect rising prices or slower deliveries some time toward the end of the year. Two facts in rebuttal: one, none of this has happened yet; and two, much of this worry has been triggered by the Fed's action and prospective actions.

Now, we may be on the verge of a self-fulfilling prophecy: The Fed's pre-emptive strike against inflation may have assured its arrival; then the Fed will have to swing at its favorite menace ever harder.

Hobart Rowen

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