Inflation Scare Haunts U.S. Policy-Makers, Investors : Economy: Despite evidence of stability in prices, a financial anxiety attack is putting pressure on the Fed.
Just last month, Federal Reserve Board Chairman Alan Greenspan proclaimed that, after three decades on the loose, the specter of inflation almost had been banished from the U.S. economy.
“At current inflation rates, we are quite close to attaining this goal,” the nation’s chief inflation cop proudly told a dinner audience at the Economic Club of New York.
Yet within weeks of that cheerful assessment, a financial anxiety attack swept the U.S. economy: Government data signaled a surprising surge in consumer prices, speculators embarked on a frenzy of gold-buying as an inflation hedge and policy-makers faced sudden pressure to ease all the fears.
For Greenspan’s Fed, the inflation scare couldn’t have come at a worse time. Keeping the lid on prices now must be balanced against the risk of torpedoing an already shaky economic recovery.
“It’s white-knuckle time for the Fed,” said Robert H. Chandross, chief economist at Republic National Bank in New York.
Many analysts say they believe that the struggling U.S. economy craves the Adrenalin of lower interest rates, not the depressant of higher ones. Yet, by some accounts, the Fed may be tilting toward modestly higher interest rates in the coming weeks to challenge even the perception of new inflation.
A simple question lies at the heart of the policy predicament, a question that in recent weeks has increasingly bedeviled investors, confused consumers and added new risks to the sluggish recovery: How much is inflation heating up?
Evidence from the real, bricks-and-mortar economy suggests that the answer is: not much.
Attention-getting price hikes have been imposed this year on several key products, including steel, lumber, paper and automobiles. The weak U.S. dollar has pushed up prices on many imports, along with their American counterparts.
Fear of White House price controls and the possibility of new regulations has prompted some increases, in health care for example.
With the help of some bad winter weather, the consumer price index shot up in April and is running at a 4.2% rate so far this year, compared to a more benign 2.9% in 1992. The CPI has risen an average of 3.81% annually since 1983.
“Are these one-shot events or are we going to have a succession of them?” asks Robert G. Dederick, chief economist at Northern Trust Co. in Chicago, of the highly publicized price increases in steel, autos and other areas. “The jury’s out on that.”
Still, Dederick and most other experts don’t foresee inflation shooting much over 3.5% this year. For all the talk, the traditional shortages that propel prices upward are nowhere to be found.
Millions of workers remain unemployed or in part-time jobs, so it comes as little surprise that wage levels are stable. Factories are churning below capacity. Real estate prices in Southern California and some other regions are flat or falling.
Yet, the limited evidence of inflation has struck a public nerve for reasons that go far beyond retail price tags or other evidence from daily life, some maintain.
News of the gaping federal budget deficit, for example, sparks worries that the government ultimately will have no choice but to pay it off by printing more, cheaper dollars--a sure-fire formula to rekindle inflation.
Indeed, the recent spate of news about inflation had a highly emotional effect on many investors, said Bruce L. Kaplan, president of a precious metals consulting firm in Santa Monica.
“They freaked out. And when they freak out fiscally, they always turn to gold. . . . My phone hasn’t rung like this in 10 years.”
Whether or not the concerns are justified, the very existence of inflationary fears is a troubling new development for national policy-makers. The anxieties can affect the economy in various ways and even prove self-fulfilling.
Lenders may demand higher interest rates to protect themselves from being repaid with dollars that have shrunk in value. Business executives and consumers may alter their behavior in ways that distort the economy.
In the 1970s and early 1980s, for example, a get-it-while-you-can credo infected the economy as people bought goods they didn’t yet need--ratcheting up prices--because they figured it would cost more if they dallied.
Investors played a game with inflation, loading up on such “hard” assets as land, homes, paintings and other collectibles.
While virtually no one foresees a replay of those troubled times, some analysts argue that even fledgling signs of an inflation psychology must be dealt with sternly. For the Fed, the issue becomes one of credibility as well as economics.
The gold rally was really “an inflation anxiety attack--and that has to be addressed by the Fed,” said Raymond A. Worseck, chief economist at A.G. Edwards & Sons Inc., a securities and investment firm in St. Louis.
Reportedly, that could happen shortly. Although the Fed’s policy committee meets behind closed doors, a Wall Street Journal account of last week’s deliberations suggested that Fed governors may soon tilt toward higher interest rates.
Key details of the policy are not yet known, and many economists say they believe that any changes will be subtle. They find it implausible that the Fed would jeopardize the uncertain recovery with a tough approach to interest rates.
Clearly, signs of a struggling expansion have been mounting in tandem with the inflation fears, including reports earlier this week of sinking consumer confidence and stagnant factory orders of big-ticket items.
“They’re probably responding more to the markets’ worries about inflation than to their own worries,” William C. Dudley, an economist at investment banker Goldman, Sachs & Co., said of the Fed.
Whatever the risks, some economists argue that the battle against inflation should be waged as long as the expectation of price increases influences business and investment decisions. The goal is not zero inflation, but rather, a level so modest that people ignore it, they say.
