Inflation phantom haunts the Fed

NOW IT IS America's turn to engage in the Great Inflation Debate that has plagued Europe in recent years.

Was Alan Greenspan right to stalk the inflation menace by engineering aggressive increases in interest rates that stunned the markets and led to huge losses on Wall Street? Or did the governors of the Federal Reserve Board over-react, sacrificing hundreds of thousands of potential jobs when the core inflation rate shows no sign of growing?

In retrospect, after being caught badly off guard by the unexpectedly steep market slide, the Fed now says it was doing Wall Street a favour. Mr Greenspan and his fellow governors have let it be known that they wanted to generate a 'significant' sell-off in equities - to curb the speculative fever that was threatening a Japanese-style stock market crash. Of course, no one expected that consecutive short- term rate increases - three in three months - would completely unhinge the bond markets, creating not a 'sell-off' but a tidal wave of negative activity in equities markets.

The very banks that Mr Greenspan & Co are accused of trying to protect, at the expense of jobs and economic expansion, are floundering in a sea of trading losses.

The second-quarter results at Bankers Trust, Citicorp, JP Morgan, Chemical Bank and other big bank and non-bank investors are expected to reflect these losses. One Fed official said the US central bank was so preoccupied with curbing speculation in equities that it failed to realise that the real 'bubble' was in bonds.

Critics contend that the Fed over-reacted and is poised to do so again, to prevent an elusive outbreak of inflation that does not appear to be grounded in economic results. True, the US economy expanded at a sizzling annual growth rate of 7 per cent in the fourth quarter and is expected to grow by a solid 3 per cent or more throughout this year.

However, actual inflation remains low at 3 per cent and the core inflation rate, which excludes food and energy prices, shows no sign of turning up. Almost all price indicators remain benign. So why all the fuss?

A critical issue is unemployment. It is seen as the best single indicator of when the economy reaches a point, as measured by labour and product markets, of accelerating inflation. This is called the 'natural rate of unemployment'. Recent gains in US employment growth, which is expected to rise to 3.1 million new jobs this year from 2 million last year, has given fresh ammunition to the inflation hawks at the Fed and in the bond markets.

However, several distinguished economists warn that pursuit of such a narrow anti- inflation goal, particularly one as questionable as the 'natural' unemployment rate, risks too much unecessary pain.

The official rate of US unemployment is now at 6.5 per cent. Those who use the natural rate of unemployment as an inflation guide, put it at anywhere from 6 to 6.75 per cent - although the Clinton administration used 5.5 per cent as its guide before recent revisions of the data.

The Nobel Laureate Robert Solow questions whether there is a 'natural' unemployment rate for the US. He further suggests that the US risks contracting 'Europe's disease' if it single-mindedly stalks the inflation threat when no such threat exists.

In a paper entitled Europe's Unnecessary Unemployment, Mr Solow contends that a significant contributing factor to Europe's escalating joblessness since the late 1970s has been a rigid adherence to too-tight monetary policies.

Growing numbers of US economists are now echoing this theme. Chief among them is Alan Blinder, recently nominated to be the Fed's vice- chairman. He argues that failure to reduce unemployment to low levels can be a greater loss of national welfare than letting inflation rise.

Meanwhile, the US economy has a lot to applaud. Consumer demand is rising, the credit crunch has abated, corporate balance sheets look healthier. Perhaps the biggest cause for celebration is the recent surge in productivity growth, which has resulted in barely rising unit labour costs. Output per hour (non-farm) has been rising at a 2 per cent annual rate.

Non-inflationary growth potential is thus seen by many as far higher than in the 1970s and '80s, another good reason the Fed should go carefully.

Start your day with The Independent, sign up for daily news emails
PROMOTED VIDEO
News
ebooksNow available in paperback
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating
and  

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Sheridan Maine: Commercial Finance Manager

Up to £70,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Sheridan Maine: Regulatory Reporting Accountant

Up to £65,000 per annum + benefits: Sheridan Maine: Are you a qualified accoun...

Ashdown Group: Marketing Services Manager - (communications, testing, DM)

£32000 - £35000 per annum + benefits: Ashdown Group: Marketing Services Manage...

Guru Careers: Finance Account Manager

£Neg. (DOE) + Excellent Benefits: Guru Careers: A Finance Account Manager with...

Day In a Page

Homeless Veterans appeal: 'You look for someone who's an inspiration and try to be like them'

Homeless Veterans appeal

In 2010, Sgt Gary Jamieson stepped on an IED in Afghanistan and lost his legs and an arm. He reveals what, and who, helped him to make a remarkable recovery
Could cannabis oil reverse the effects of cancer?

Could cannabis oil reverse effects of cancer?

As a film following six patients receiving the controversial treatment is released, Kate Hilpern uncovers a very slippery issue
The Interview movie review: You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here

The Interview movie review

You can't see Seth Rogen and James Franco's Kim Jong Un assassination film, but you can read about it here
Serial mania has propelled podcasts into the cultural mainstream

How podcasts became mainstream

People have consumed gripping armchair investigation Serial with a relish typically reserved for box-set binges
Jesus Christ has become an unlikely pin-up for hipster marketing companies

Jesus Christ has become an unlikely pin-up

Kevin Lee Light, aka "Jesus", is the newest client of creative agency Mother while rival agency Anomaly has launched Sexy Jesus, depicting the Messiah in a series of Athena-style poses
Rosetta space mission voted most important scientific breakthrough of 2014

A memorable year for science – if not for mice

The most important scientific breakthroughs of 2014
Christmas cocktails to make you merry: From eggnog to Brown Betty and Rum Bumpo

Christmas cocktails to make you merry

Mulled wine is an essential seasonal treat. But now drinkers are rediscovering other traditional festive tipples. Angela Clutton raises a glass to Christmas cocktails
5 best activity trackers

Fitness technology: 5 best activity trackers

Up the ante in your regimen and change the habits of a lifetime with this wearable tech
Paul Scholes column: It's a little-known fact, but I have played one of the seven dwarves

Paul Scholes column

It's a little-known fact, but I have played one of the seven dwarves
Fifa's travelling circus once again steals limelight from real stars

Fifa's travelling circus once again steals limelight from real stars

Club World Cup kicked into the long grass by the continued farce surrounding Blatter, Garcia, Russia and Qatar
Frank Warren column: 2014 – boxing is back and winning new fans

Frank Warren: Boxing is back and winning new fans

2014 proves it's now one of sport's biggest hitters again
Jeb Bush vs Hillary Clinton: The power dynamics of the two first families

Jeb Bush vs Hillary Clinton

Karen Tumulty explores the power dynamics of the two first families
Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups

Stockholm is rivalling Silicon Valley

The Swedish capital is home to two of the most popular video games in the world, as well as thousands of technology start-ups worth hundreds of millions of pounds – and it's all happened since 2009
Did Japanese workers really get their symbols mixed up and display Santa on a crucifix?

Crucified Santa: Urban myth refuses to die

The story goes that Japanese store workers created a life-size effigy of a smiling "Father Kurisumasu" attached to a facsimile of Our Lord's final instrument of torture
Jennifer Saunders and Kate Moss join David Walliams on set for TV adaptation of The Boy in the Dress

The Boy in the Dress: On set with the stars

Walliams' story about a boy who goes to school in a dress will be shown this Christmas