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
News
Sir David Attenborough
people
Life and Style
Young girl and bowl of cereal
food + drink
Arts and Entertainment
'The Archers' has an audience of about five million
radioA growing number of listeners are voicing their discontent; so loudly that even the BBC's director-general seems worried
News
news
PROMOTED VIDEO
ebooks
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
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

Ashdown Group: Market Research Executive

£23000 - £26000 per annum + Benefits: Ashdown Group: Market Research Executive...

Recruitment Genius: Technical Report Writer

£25000 - £35000 per annum: Recruitment Genius: A Technical Report Writer is re...

MBDA UK Ltd: Indirect Procurement Category Manager

Competitive salary & benefits!: MBDA UK Ltd: MBDA UK LTD Indirect Procurement...

Recruitment Genius: Web Developer - PHP

£16500 - £16640 per annum: Recruitment Genius: This fast growing Finance compa...

Day In a Page

Isis hostage crisis: Militant group stands strong as its numerous enemies fail to find a common plan to defeat it

Isis stands strong as its numerous enemies fail to find a common plan to defeat it

The jihadis are being squeezed militarily and economically, but there is no sign of an implosion, says Patrick Cockburn
Virtual reality thrusts viewers into the frontline of global events - and puts film-goers at the heart of the action

Virtual reality: Seeing is believing

Virtual reality thrusts viewers into the frontline of global events - and puts film-goers at the heart of the action
Homeless Veterans appeal: MP says Coalition ‘not doing enough’

Homeless Veterans appeal

MP says Coalition ‘not doing enough’ to help
Has The Archers lost the plot with it's spicy storylines?

Has The Archers lost the plot?

A growing number of listeners are voicing their discontent over the rural soap's spicy storylines; so loudly that even the BBC's director-general seems worried, says Simon Kelner
Human skull discovery in Israel proves humans lived side-by-side with Neanderthals

Human skull discovery in Israel proves humans lived side-by-side with Neanderthals

Scientists unearthed the cranial fragments from Manot Cave in West Galilee
Valentine's Day cards: 5 best online card shops

Don't leave it to the petrol station: The best online card shops for Valentine's Day

Can't find a card you like on the high street? Try one of these sites for individual, personalised options, whatever your taste
Greece elections: In times like these, the EU has far more dangerous adversaries than Syriza

Greece elections

In times like these, the EU has far more dangerous adversaries than Syriza, says Patrick Cockburn
Holocaust Memorial Day: Nazi victims remembered as spectre of prejudice reappears

Holocaust Memorial Day

Nazi victims remembered as spectre of prejudice reappears over Europe
Fortitude and the Arctic attraction: Our fascination with the last great wilderness

Magnetic north

The Arctic has always exerted a pull, from Greek myth to new thriller Fortitude. Gerard Gilbert considers what's behind our fascination with the last great wilderness
Homeless Veterans appeal: Homeless in Wales can find inspiration from Daniel’s story

Homeless Veterans appeal

Homeless in Wales can find inspiration from Daniel’s story
Front National family feud? Marine Le Pen and her relatives clash over French far-right party's response to Paris terror attacks

Front National family feud?

Marine Le Pen and her relatives clash over French far-right party's response to Paris terror attacks
Pot of gold: tasting the world’s most expensive tea

Pot of gold

Tasting the world’s most expensive tea
10 best wildlife-watching experiences: From hen harriers to porpoises

From hen harriers to porpoises: 10 best wildlife-watching experiences

While many of Britain's birds have flown south for the winter, it's still a great time to get outside for a spot of twitching
Nick Easter: 'I don’t want just to hold tackle bags, I want to be out there'

'I don’t want just to hold tackle bags, I want to be out there'

Nick Easter targeting World Cup place after England recall
DSK, Dodo the Pimp, and the Carlton Hotel

The inside track on France's trial of the year

Dominique Strauss-Kahn, Dodo the Pimp, and the Carlton Hotel: