Inflation Fight

May 16, 2000 at 12:00 AM EDT

GWEN IFILL: The decision by Alan Greenspan and the other members of the Federal Reserve to raise interest rates today was the most forceful in a series of moves to slow a booming– some say pre-inflationary– economy. The half-point hike is the largest since 1995, and brings the Federal Fund’s rate, as its known, to 6.5%, its highest level since 1991. Signs of economic growth abound: The Gross Domestic Product, the broadest measure of the economy, grew at a rate of 5.4% in the first quarter of the year. That followed an even stronger 7.2% in the fourth quarter of 1999. And the American job machine keeps churning. In April, the nation’s unemployment rate fell below 4% for the first time in 30 years.

SPOKESPERSON: All set today?

GWEN IFILL: Labor Department statistics showed that businesses added 340,000 jobs to their payrolls last month, more than economists anticipated. The report also showed the lowest recorded jobless rates ever for blacks and Hispanics: Black unemployment at 7.2%; Hispanic unemployment at 5.4%. But these strong growth numbers have spurred worries of impending inflation, the Fed’s chief concern. In March, the core Consumer Price Index, which includes all items except food and energy, rose 0.4%– the steepest increase in five years– and the overall CPI saw its second big jump in consecutive months. Numbers released today, however, showed the CPI unchanged. Another closely watched indicator of inflationary pressure, the Employment Cost Index, measures wages and benefits. It increased 4.3% in the year’s first three months, the fastest pace in 12 years. Economists worry that these numbers, taken together, could send the nation spinning into an inflationary spiral: Tight labor markets leading to higher wages, leading to higher prices for consumer goods. Today the Fed expressed similar fears, saying in a statement it “is concerned that the disparity in the growth of demand and potential supply will continue, which could foster inflationary imbalances that would undermine the economy’s outstanding performance.”

GWEN IFILL: For a closer look at the factors leading to– and potential fallout from– today’s interest rate hike, we’re joined by four economists: William Spriggs is director of research and public policy at the National Urban League. Diane Swonk is chief economist at Bank One in Chicago, and the president of the National Association for Business Economics. Don Ratajaczak is director of Georgia State University’s economic forecasting center. And Philip Romero is dean of the Lundquist College of Business at the University of Oregon. He’s the former chief economist for the State of California. Diane Swonk, was it the right thing to do to raise interest rates again?

DIANE SWONK, Bank One: Right. I think this is a difficult time for Fed policy and Fed policymakers. We’re at the stage of the game where the Fed is trying to pull in the reigns a bit on an economy that is growing exceedingly fast. That’s not bad news, but what’s what the Fed’s attempting to do is to start raising rates today to try the damping inflationary pressures within next six to 12 months. It’s also important to note that inflation has picked up a little bit. But it’s still so low, that most of us don’t think it’s a problem. For Fed policymakers, that’s disturbing because if momentum has clearly shifted, they need to start today to have an impact later on. I frankly think we’re still going to see a lot more inflation in this cycle. The good is that inflation acceleration will be gradual. I don’t think the Fed will succeed in slowing down the economy very much this year. That’s good news for some, it’s bad news later in this cycle for additional inflation.

GWEN IFILL: Mr. Spriggs, is inflation a big enough fear that it would justify raising interest rates again today?

WILLIAM SPRIGGS, National Urban League: I don’t think it is. I think that the greater fear is that the Fed may be overestimating its own abilities to monitor the economy. There are great downside risks to this economy. We have government expend church rate, which is designed to run a surplus. That’s a drag on the economy. We have a growing trade deficit. That’s another drag on the economy. Further, for those who become unemployed, we do not have the safety net that we had in previous recessions. We have undone what were previously a type of expenditures that were entitlements that automatically made the government act as a buoy against downward risks. So I think the Fed… it isn’t just this rate increase, but the signal it wants to be very aggressive about slowing down the economy, that’s the bad sign.

GWEN IFILL: Don Ratajczak, you track inflation and inflation fears. Are the fears of inflation justified in this case?

DON RATAJCZAK, Georgia State University: Well, there’s no question that the Federal Reserve has fears of inflation. Our own indicators actually show the significant acceleration. Last September, quiet frankly, the acceleration has eased off. Sensitive crude material prices actually rose for nine consecutive months, ending in January, and have now declined for three consecutive months. And, of course, the Consumer Price Index after this big increase in March, is showing very small increases in April. My guess is we’ll have a small increase in May, as well. So the question here isn’t inflation. I think what the Federal Reserve is truly worried about is that 8.3% real growth in consumer spending, that’s far in excess of consumer incomes, and they’re worried about the increased debt and the unbalanced effect that that consumer surge is creating.

GWEN IFILL: How about that, Philip Romero? You’re at a college at a university campus where you see students getting ready to go out into the world and spend all their money at the fastest possible rate. Do you have a sense whether inflation is an overblown fear or whether it’s something that we’ve already seen the worst of it. Or as Diane Swonk say, it’s about to get worse?

PHILIP ROMERO, Dean, University of Oregon Business School: I generally agree with Ms. Swonk. The Fed unquestionably had no choice but to do what it did. It’s been tapping on the brakes very lightly for approximately a year, with virtually no effect on wages or inflation at all. The fundamental issue the Fed has to deal with is the fact that it’s effectiveness is declining. As more and more consumer spending is buoyed by growth in assets that have nothing to do with borrowing, the Fed is facing a situation of declining ability to affect the economy, and so therefore they have to push stop brakes even harder.

GWEN IFILL: As a matter of fact, Mr. Romero, this is the sixth time the Fed has raised rates since last June, do we have any evidence it’s slowed the economy down.

PHILIP ROMERO: Well, of course, we never know what would have happened if they hadn’t, but I think it’s fair to say it’s probably slowed the economy very slightly. But the fundamental economic challenge is that consumers are choosing not to save because they’re counting on growth in their assets, as a result of the booming stock market, to pay for their consumption. As long as that stock market continues to justify their high spending, that consumer demand is going to chase wages upward. So that’s the fundamental inflation problem that the Fed has had to deal with. It can’t affect consumer spending directly, so it affects it indirectly, and, as I said, with the declining effectiveness.

GWEN IFILL: So Diane Swonk, we see the SUV’s being filled up with more expensive gasoline, people buying more expensive homes. What’s fueling this economic boom, and is it something people should be confident about?

DIANE SWONK: Well, I think there’s a main issue fueling this economic boom that most people keep ignoring. We all focus on the stock market because that’s an easy indicator to focus on, and clearly it has had an impact. Two other areas I think are much more important — the fact that people can tap into their home equity in ways they couldn’t in the past, taking out home equity homes, right now at an extraordinary record pace and spending that money, turning around and buying cars with it. On the flip side, though, something more fundamental is under way here, and this is something that the Fed has a hard time stopping and doesn’t want to necessarily eliminate, but it’s one of the reasons this train is running so fast, and that is tight labor market conditions. The money in people’s pockets is growing again. That is the single most important determinant of consumer spending that exists. It’s not something that we had helping us out in terms of real wage gains for much of the last 30 years. And it’s returned. There’s just nothing more powerful than the money in people’s pockets growing to boost confidence, lift attitudes and even increase people’s willingness to take on debt. That extends far beyond the reach of Wall Street to Main Street. It’s not bad news until it has consequences. When you see this economy with such tight labor markets that some companies, I know this for a fact, in Michigan, have actually had to close down for their inability to be able to staff plants, something extraordinary. It’s the first time we’ve seen plants close because of good economic conditions. There’s clearly a price to good economic growth.

GWEN IFILL: Let’s talk about another kind of price, Mr. Spriggs. Obviously we saw that unemployment is down to a record 30-year low, and blacks and Hispanics are leading that. You’re with the Urban League. Is anyone losing out on this boom?

WILLIAM SPRIGGS: Well, there are still people left behind, and it’s clear when you walk into rural areas of this country, where unemployment has not dipped to the 1% that you see in many cities, and it’s clear within certain neighborhoods in cities that the growth has not extend everywhere. I think the remarkable thing about this growth pattern is you see how many people have been drawn into this labor market. One of the remarkable things about the black unemployment rate is not just that it’s at a record low, but the participation. So the myth that there weren’t people out there is being blown away by the number of people being drawn into this labor market who hadn’t been there before. So I think it’s misleading to think that there are real labor pressures out there. We have not seen wages grow faster than productivity plus inflation, and that’s what really concerns businesses, because that is the bottom line — the unit labor cost. And they have not grown in any store their way. So the cost of doing business per worker, given their output, given this growth in productivity hasn’t gone. And people thought when we went down in the unemployment rate and when the black unemployment rate, when the Hispanic unemployment rate fell, that we were bringing in workers who weren’t going to be productive, and yet we’ve seen productivity continue to increase. We’ve seen unit labor costs go down. So I think that we’ve operated with a lot of myths about what this labor market looked like. The other thick is that because of affirmative action, women are much more skilled than we had in the 70’s and the 80’s. African-Americans have an education attainment close to whites. The overall labor market is much more skilled. So workers don’t have the luxury of being able to bid up wages as they did before.

GWEN IFILL: Mr. Ratajczak, what about that? Maybe that’s the good side of a little inflation. What’s wrong with a little inflation between friends?

DON RATAJCZAK: Well, actually, I think that is one of the good sides of a little inflation. In fact, I worked on a paper about two years ago in which we started to see this trend of declining unemployment in minorities. And our argument was that because these people are developing a resume, they’re getting experience in the workforce, that they can no longer be put in that pool of frictional unemployed, and therefore, the true unemployment rate that we could attain without creating inflation actually falls as we give these people more and more experience. And I think that that has proved to be the case. There is a benefit to bringing these people into the workforce, giving them experience, giving them an opportunity to work in the market economy. And I don’t think that that’s the real issue here, although some economists talk about it. The real issue right now is consumer imbalance. Consumers are spending faster than they’re earning. Yes, they are earning more, but they’re spending even faster than they’re earning because they believe the future is going to be better than even current conditions are. Now, that belief may not be correct, and that’s when we might start to see problems in this economy.

GWEN IFILL: Mr. Romero, if it’s true that in fact people are spending more than they’re taking in or they’re spending more quickly than they can produce, it brings to mind, you know, that maybe an old adage that suggests that maybe the Fed is overreaching, which is that expansions don’t die, the Fed kills it. Is that possible in this case, that the Fed may have made a misstep or may be taking too drastic a step in this?

PHILIP ROMERO: That’s what I was eluding to before, Gwen. The common way that expansions end is the central bank is asleep at the switch. Lets inflation get out of control and then has to slam on the brakes to bring things back into balance. That’s precisely why I said the Fed has no choice. It appeared over the last few months, as other panelists have said, that inflation was starting to accelerate. And I think this dose of preventative medicine is one of the best ways to avoid the traditional end of an expansion.

GWEN IFILL: We, Ms. Swonk, always look to Wall Street to see what the reaction is. Today they seemed to take it quite in stride. What are we to read into that?

DIANE SWONK: I think Wall Street had already priced this in. I think Wall Street keeps wanting to fool itself, call it the necessary lies investors are telling themselves at this stage in the day, that the next Fed move will be the last movement that is not going to be the case. This Fed is far from over in tightening. I think it’s also important to note here that the Fed has no designs in increasing the unemployment rate at this stage of the game or a recession or running the risk of recession. And I don’t think given the momentum in this economy they will. In fact, we might even see some fiscal stimulus add to the equation over next year or so. But with all that said, what does that mean? Over the longer haul, if the Fed’s not willing to raise the unemployment rate today, which I don’t think they should, they may be willing to run the risk of getting behind the curve on inflation if, in fact, labor markets are already too tight and inflationary pressures have already built. I think that’s a risk worth running at this stage of the game, but let’s be clear where the risks are. The Fed’s not risking recession, they’re risking additional growth and some inflation, and that may be the prudent thing to do at a low level of inflation, but it may mean more inflation in a few more years.

GWEN IFILL: Mr. Ratajczak, is it possible that this economy is too hot to be slowed by something that the Central Bank does?

DON RATAJCZAK: No question in my mind that the Central Bank can slow this economy. It may require a much more aggressive restraint than they’ve currently shown. In fact, my big concern is when you take a look at Federal Reserve action in the past, they’ve started timid, moved slowly, and then basically lost their patience and became more aggressive — and then ultimately, finally got up to speed when the train had already passed the station that they needed to stop at. And right now this Federal Reserve is following that pattern, and that’s a little bit disturbing to me.

GWEN IFILL: Do you agree with that, Mr. Spriggs?

WILLIAM SPRIGGS: I totally agree with that. I mean, the big concern here is not that they raised it this one time: I don’t think that’s going to cause a recession. But if they’re taking an aggressive stance that they must slow down the economy, I think that they’re overplaying, they’re being too confident in their ability to get us to grow in a very slow way. And again, what they’re going to stop will be those parts of the economy which really aren’t causing the problem — and therefore throwing out some people out of jobs who aren’t really going to be able to slow the economy down anyway. So I think that’s the real concern here.

GWEN IFILL: We’ll leave it right there. Thanks, everybody.