Greenspan Walks the Right Path

The Federal Reserve’s quarter-point hike in a key interest rate Wednesday displays Chairman Alan Greenspan’s struggle to keep ahead of the inflationary curve without endangering further growth. It leaves the Fed enough room to tighten interest rates further if the imbalances persist.

The Fed policymaker’s decision to raise interest rates, the fourth such increase since last June, came with a warning that inflationary pressures within the booming economy are building and could torpedo future growth. Clearly, the previous three hikes haven’t eased the inflationary imbalances.

What worries the Fed most is that the growth in demand--stimulated by consumers’ unbridled spending--is outpacing supply and that the prices of assets such as real estate and corporate stocks are rising dramatically. Labor costs too are increasing, but more slowly.

The rate hike is calculated to make borrowing, both by businesses and consumers, more expensive and slow down future expansion.

The relatively modest rate hike in the face of the torrid pace of economic growth shows that Greenspan is at least a partial convert to the “new economy.” In his speeches, he now acknowledges that the strong increases in productivity, a measurement based on the cost of labor required to produce a particular good, will help hold down inflation. But he also says that even the new economy has not repealed the ups and downs of the economic cycle. The Fed’s gradualist approach is the right one and should continue until the red-hot economy comes to a soft landing.