Give Greenspan Credit for Going Slow on Monetary Policy

This past week, the Federal Reserve shifted its current policy by signaling a greater inclination to tighten money to resist inflation. The Fed’s policy-setting open-market committee did not actually raise short-term interest rates at its Tuesday meeting, but opened the door to doing so, soon.

Higher interest rates would cool the economy, slow growth and presumably damp down the risk of inflation. But is such a move necessary, or wise?

That depends on just how new you think the new economy is, and where its inflationary threats lie. There is little doubt that some things about the economy really have changed.

For one thing, in an information economy, many products actually get cheaper as they get better, computers and telecommunications being epic cases in point. The more the economy is rooted in information technology, the greater the tendency for price cuts.

For another thing, deregulation and globalization have increased price competition. Manufacturers find it hard to make price increases stick; the consumer just goes elsewhere.

Further, in a globalized and deregulated economy, labor has lost bargaining power. Unemployment rates are well below 5%, but wage increases have been modest. Productivity is dramatically up, an astonishing 4% per year during the last two quarters, and is outpacing labor costs.

All of these elements are genuinely new. On the other hand, some of the economy’s remarkable ability to resist inflation in the booming late 1990s is just lucky timing.

For example, the prices of raw materials have been unusually low. But that may not go on forever.

In addition, the strong U.S. economy has produced a relatively strong dollar, which means prices of imports stay low. That may not continue indefinitely either.

On balance, however, it is hard to discern very much inflationary pressure of the sort that would justify a Fed policy of deliberately slowing growth.

Signs of inflation are coming from just two sources, neither of them significant. The so-called “core” rate of inflation, which reflects actual economic overheating, remains quite stable.

Oil prices have increased in recent months, leading to a rise in the April inflation rate (the Consumer Price Index) to 0.7%, up from 0.4% in March. This, however, seems to be a temporary blip, not a resurgence of OPEC or a general tightening of demand.

Also, health insurance costs, after staying almost level for three years, are rising again. But this is a unique sectoral phenomenon, driven by the fact that the easy cost savings of managed care have been realized. It does not suggest the sort of generalized economic overheating that should legitimately trouble the Fed.

Alan Greenspan differs from his recent predecessors in one key respect. He is less inclined to accept the idea that the Fed should act to choke off prosperity prophylactically, because inflation might be somewhere over the next hill.

He does not buy the old idea that there is a mechanical trade-off between inflation and unemployment. Rather than looking to models, he looks at the actual numbers.

In considering the economy’s recent numbers, one grasps the immense benefits of higher rates of growth, which should not be abandoned lightly. Consider:

* Thanks to higher growth rates since the mid-1990s, the federal budget went into surplus four years ahead of schedule.

* With higher growth, the Social Security crisis may virtually solve itself. One year of robust growth was enough to push back the Social Security system’s projected day of reckoning by three years, thanks to higher tax receipts.

* With higher growth and lower unemployment, workers in the bottom half of the earnings distribution are actually realizing real wage gains, for the first time in two decades.

* The current rates of unemployment among blacks and Latinos, long stuck in double digits, are now 7.7% and 6.9%, respectively.

* Crime may well be declining, not just because of tougher policing, but because long-marginalized people in the economy actually have brighter horizons.

Welfare reform is leading not just to punitive removals from the rolls, but to jobs for many former recipients. But this is possible only because unemployment is so low.

Before the Fed tosses all of this away because of imagined inflation, it should take stock of these remarkable benefits. Greenspan could go down in history, not just as the Fed chairman who presided over a period of stunning economic recovery, but as the first Fed chairman who was not trigger happy about inflation.

Given his own history as an arch-conservative and the culture of his institution, that is no small achievement.