Posted on: Tuesday, July 6, 2004

EDITORIAL
Inflation: Crying wolf or too late already?

No one should be surprised that the Federal Reserve Board has finally raised interest rates as inflation shows signs of renewal after four years of cowering quiescence.

Indeed, it's widely assumed the Fed will steadily raise the federal funds rate a half-dozen times, a quarter-point a pop, into 2005.

What may be a surprise is the actual, eventual effect of Fed Chairman Alan Green-span's strategy, because the levers available to him are anything but fine-tuned instruments.

Some critics suggest that the Fed's nostrum won't tame inflation but instead stifle a struggling economic recovery.

Why raise rates now, asks economist Ellen Frank, with the core inflation rate at less than 2 percent, and after three years of stagnant job growth and declining real wages, with the labor market only just beginning to show signs of life? (The Labor Department said last week that only 112,000 jobs were created last month, far fewer than the 250,000 forecasters had expected.)

Frank, author of "The Raw Deal: How Myths about Deficits, Inflation and Wealth Impoverish America," decries the actions of the Fed, "an unelected, secretive body with intimate ties to the finance industry," which, with no input from the public or even Congress, decides "the most monumental question of economic policy — how much unemployment should a civilized society tolerate?"

Perhaps Frank has forgotten how in the 1970s inflation, that rapacious creditor, savaged the finances of the very people she seems most concerned about.

In fact, some of Greenspan's critics fault him for moving against inflation too slowly.

Greenspan, said one economist, allowed too much inflationary pressure to build before finally beginning to apply the brakes.

"Everyone recognizes that holding the Fed funds rate below the inflation rate is a recipe for accelerating inflation," said this economist, "because it creates an incentive for people to go out and buy things and finance them at relatively low rates" — which drives inflation even faster.

Look no further than the rush in Hawai'i to buy homes before rates go up, with prices soaring as a consequence.

The big unknown in this equation is the tolerance of American households for indebtedness. When the Fed quickly reduced interest rates to unprecedented lows from 2001 to last year, "it openly invited households to borrow, and they heartily accepted," observed The Economist — to the point where their debts now equal 115 percent of their disposable incomes.

If wages, property and stocks rise steadily enough to keep that indebtedness tolerable, all is well. But isn't it beginning to appear that the value of some of their assets, perhaps equities and houses, are a little overvalued?

If so, says The Economist, "one of the most important sources of demand for the American economy, the uninhibited spending of unearned money, may thus begin to dwindle," knocking the legs out from under economic recovery before it can stand on its own.

That, we're sure Greenspan would agree, would be a most unfortunate unintended consequence of his fiscal policy.