Bush Must Take Off His Blinders on Inflation

Robert J. Samuelson writes about economic issues from Washington

George Bush and his economic lieutenants say that they want to encourage long-term economic thinking. The President should heed his own advice and stop heckling the efforts of Federal Reserve Chairman Alan Greenspan to curb inflation. Combating inflation is a classic case of doing something difficult today for much larger benefits tomorrow.

The President disclaims any fight with Greenspan. But Bush's complacency about inflation amounts to the same thing. He has said repeatedly that he sees no signs that it's getting worse. The message is that the Fed shouldn't raise interest rates any further. Presumably Bush fears an economic slowdown or even a recession. His popularity could suffer, and cutting the budget deficit would be tougher. These would be serious short-term problems.

Ignoring inflation, though, poses bigger risks. Bush's rhetoric could scare financial markets--all investors in the stock, bond and foreign-exchange markets. If they think that the Fed will retreat, fears of inflation could trigger a crisis. It would probably begin in the foreign-exchange markets, where investors in dollars would try to switch out of the currency. The Fed might then have to raise interest rates sharply to make holding dollars more profitable and to calm inflation anxieties.

The more troubling possibility is that the Fed would simply back off quietly. There would be no immediate crisis, but inflation would gradually worsen. The higher the inflation goes, the harsher the ensuing recession required to bring it down.

It's easy to see why Bush might minimize inflation fears. In 1988 the consumer price index, the best-known inflation indicator, rose 4.4%--the same as in 1987. But the steep 0.6% increase in the index for January (7.2% at an annual rate) announced Wednesday should dispel any optimism. A close look at economic statistics confirms intensifying price pressures. Consider:

--The stability of the consumer price index in 1988 was misleading. It mostly reflected a drop in oil prices. Excluding energy prices, the index rose 4.7% in 1988. In 1989 oil prices are expected to rise, adding to inflation.

--A broader measure of price changes (the price index of the gross national product) is accelerating. It rose 4.5% in 1988. This indicator reflects all prices, not just consumer prices.

--Labor costs for business are growing more rapidly. They rose 4.9% in 1988. Wages and fringe benefits are the biggest expense for most companies. Increases exert pressure on most prices.

--Producer prices--paid by businesses for raw materials, machinery and finished consumer goods--are increasing sharply. In January, prices for intermediate materials (chemicals, lumber, metals, auto parts, fabrics and feeds) were 6% higher than a year earlier. These extra expenses tend to raise the prices of finished products.

Inflationary pressures can subside in two ways. By becoming more efficient, businesses can absorb higher labor and material costs without passing them along to consumers in higher prices. The other way is for the economy to experience a slowdown or recession. Prices are held down by more ample, or surplus, supplies of consumer goods and machinery. Higher unemployment restrains wage increases.

Since last spring the Fed has tried to induce a slowdown. It raised the key interest rate under its control, the "Fed funds" rate that banks pay to borrow overnight, by about 3%. But the economy has slowed only slightly. One reason is that long-term interest rates outside the Fed's control, like mortgage rates, have barely risen.

"The economy isn't as interest-rate-sensitive as people like to think," says economist Richard Berner of Salomon Brothers, the investment bankers. Rates on consumer loans have risen only modestly, he says. Berner also doubts that higher rates on existing home-equity loans or adjustable-rate mortgages will quickly dampen consumer spending. These borrowers, he says, have roughly twice the national median income and probably can handle bigger monthly payments.

Berner thinks that prices will rise more than 5% in 1989. By trying to suppress inflation gradually, the Fed may have been too timid. Just what Bush gains by cautioning the Fed isn't clear. He can't see the future any better than Greenspan can. Nor can he effectively distance himself from the Fed by preemptive criticisms. If there's a recession, he will be blamed. If inflation intensifies, he will look unnecessarily foolish for dismissing the dangers.

Perhaps only a recession can reverse rising inflation. If so, it's preferable to the alternative, which is allowing inflation to drift upward. That would hurt the economy's long-term prospects. It risks immediate stagflation--that unsettling mix of high inflation and meager growth. And sooner or later there would be a recession anyway. But its potential for good would be reduced if inflation grew worse.

These are not easy or happy choices. If Bush dares not discuss them, he'd be better off saying nothing. Contrary to conventional wisdom, the economic success of his presidency doesn't depend exclusively on what happens to the budget deficits. Inflation is equally critical. Everyone would ultimately benefit if it's controlled sooner rather than later.

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