COMMENTARY: LOW PRICES. LOW RATES. IT'S TIME TO RELAX
It's still like being in bear country, despite the market's 257-point jump on Sept. 2. Stocks get mauled every time new data show the economy growing faster than forecasters expected. Investors are scared that the Federal Reserve will tighten money to ward off inflation, and the markets swing with the ebb and flow of those fears. Well, stay calm. The Fed, it seems to me, is not about to raise interest rates anytime soon--even in the wake of higher-than-expected growth.
Skeptical? Consider the latest thinking from Fed officials, present and former, attending the Federal Reserve Bank of Kansas City's annual conference of central bankers and economists in Jackson Hole, Wyo., Aug. 28-30. Fed Vice-Chairman Alice M. Rivlin, in an interview, said that the Aug. 21 upward revision in the second-quarter gross domestic product growth--from 2.2% to 3.6%--did not increase the probability of Fed rate tightening, although the revised number exceeded the Fed's forecast.
Rivlin says the Fed is mystified by the economy. It can't explain why strong GDP growth and low unemployment have failed to push up prices. That old paradigm isn't working. If it were, the Fed would have raised interest rates a year ago, she says. ''We didn't raise rates because we didn't understand what was happening in the economy.''
NO SPARKS HERE. An economist at Jackson Hole who is familiar with Fed thinking goes even further than Rivlin. He concludes that the strong economic showing actually decreases the chance that the Fed will tighten. The reason: While growth is robust, the inflation rate is actually falling. ''That's Greenspan's bet,'' he says--that the economy can continue to expand without igniting inflation. Only signs of a pickup in prices will move Fed Chairman Alan Greenspan to raise rates, he thinks. One Fed official put the chances that the Fed will tighten when it meets on Sept. 30 at between 10% and 20%. A former official gave tightening almost no chance at all: ''There's no inflation. There's no case for raising rates.''
Greenspan attributes the lack of price pressure in the economy to the combination of global competition and the increase in productivity stemming from technological innovation. True, the rise in productivity doesn't show up in the numbers. But that's because government statisticians have failed to measure productivity gains in the service sector. ''The nonfarm productivity data,'' Greenspan said in an interview, ''are nonsense.''
But there may be another explanation for the coexistence of those apparent enemies, high growth and low inflation--one that turns the whole issue on its head. Maybe, just maybe, it's the low inflation that's actually causing economic growth to speed up. A recent study by Spanish economists Javier Andres and Ignacio Hernando, using the data for 24 countries over a 32-year period, shows that countries with low inflation grow faster than economies with higher inflation.
How does low inflation spur economic growth? For one thing, companies can plan more effectively. They are less concerned that the central bank will clamp down and send interest rates higher. They also don't have to worry about stocking their shelves with more merchandise than they need, for fear that prices will be heading higher next week or next month. Second, in a low-inflation economy, where competition is fierce, companies are unable to raise prices easily. So to maintain profit margins, they cut production costs by becoming more efficient.
SPENDTHRIFTS. Perhaps most important is how inflation affects consumers. Surveys show that people hate inflation even if their paychecks keep up with price hikes. So when inflation is on the march, discontented consumers cut their spending. Conversely, when prices are stable, consumers are happy, are more confident, and spend more. The recent rebound in consumer spending despite tepid wage gains may simply be the result of the decline in inflation.
Ironically, then, by pursuing a low-inflation policy, Greenspan himself may have pushed the economy's growth onto a higher track. To clamp down now would be like throttling back an engine that has been retooled for high-speed performance.
''The U.S. has shown the world,'' says Leif Pagrotsky, Swedish Minister of Trade, ''that it could grow over a long period of time without touching off inflation. And Greenspan played a major role in that.'' It would be surprising, indeed, if the Fed chairman, who appears to be winning his bet, were to lose heart and yield to the adherents of the old paradigm.
By Seymour Zucker
Updated Sept. 4, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.