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The Fed May Have Something To Worry About


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THE FED MAY HAVE SOMETHING TO WORRY ABOUT

Is the money supply's spike troubling? Some economists say so

Despite the Federal Reserve's secretive reputation, there was little suspense surrounding its Mar. 31 session: For the eighth consecutive meeting, policymakers opted to...do nothing. With the economy still in a blissful state of strong growth and low inflation, some Fed watchers believe the policymaking Federal Open Market Committee could stand pat for the rest of 1998.

Yet there is at least one troubling cloud on the horizon: a sharp and so far unexplained jump in the nation's money supply (chart). A few economists believe that the marked trend might be a sign that the breathtaking runup in stocks and other asset prices is spilling into the broader economy. If so, that could trigger a rise in inflation.

On Mar. 16, Allan H. Meltzer and other prominent monetarist economists--who see money flows as a leading indicator of economic output--called on Fed Chairman Alan Greenspan to raise interest rates before the economy starts to overheat. "The seeds of high inflation have been and are being sown," said the group, known as the Shadow Open Market Committee. "It is irresponsible to ignore the increased money growth of the past six months."

If Meltzer and his fellow monetarists are proven right, it would serve as sweet vindication for a once-proud theory that has flirted with irrelevancy over the past decade. During the early 1980s, Fed Chairman Paul A. Volcker cited the soaring money supply when he raised interest rates to double digits. But Volcker was never a true monetarist, and Greenspan has largely ignored money measures since the early '90s. He has argued that the shift by consumers into mutual funds, which are not counted in the money supply, broke the supply's link to gross domestic product.

But monetarists argue that growth in M2--the best measure of currency, checking accounts, and most savings accounts--has over the past year come back into sync with the pace of GDP. If true, the spike in money-supply growth could fuel a surge in output and inflation. Since December, M2 has been climbing at an 8.3% annual rate--its fastest rise since 1989 and above the 5% ceiling many monetarists deem prudent.

Even some economists who don't consider money growth troubling still worry that it could turn the slightest inflationary spark into a bonfire. "It provides the fuel for a bigger inflation problem," says First Union Corp. economist David Orr. "The more liquidity there is, the harder it'll be for the Fed to mop it all up."

Still, most economists aren't alarmed by M2's surge--yet. They attribute the recent spurt to temporary factors, including the flight of Asian investors into the dollar and the recent boom in mortgage refinancings. Taxpayers with large capital gains and corporate bonuses are likely building up their checking accounts to write big checks to Uncle Sam as well."TOO EASY." What's more, some forecasters contend that current money growth is more a sign of healthy demand than of inflation. Rising money would be worrisome, says Brian S. Wesbury, chief economist for Chicago-based Griffin, Kubik, Stephens & Thompson Inc., if gold and other commodity prices were soaring, the dollar was plummeting, and inflation-adjusted interest rates were relatively low--as in 1994. Then, the Fed did embark on an aggressive round of rate hikes to head off inflation. But now, gold is falling, real interest rates are high, and the dollar is soaring. "Of all the key monetary indicators, money growth is the only one that suggests Fed policy is too easy," says Wesbury.

Fed policymakers concede that they're intrigued by the closer correlation between M2 and GDP. Greenspan admitted in February that there were "tentative signs" of a closer link between money and output--but questioned "the stability of the relationship."

As a result, the Fed isn't ready to re-adopt the money supply as a guide for policy. The Fed's resident monetarists, regional Fed bank presidents William Poole and Jerry L. Jordan, are handily outvoted by Greenspan and other economic pragmatists. And Federal Reserve Bank of Dallas President Robert D. McTeer Jr. told a Florida audience on Mar. 27 that "with all the financial innovations we've had, it's very hard to know what the right rate of growth of the money supply is." Until the Fed's money mandarins figure that one out, M2 may remain something of a relic.By Dean Foust in WashingtonReturn to top


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