Eye on Inflation
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RAY SUAREZ: When the Federal Reserve chairman appeared before the Senate committee on banking today, it was to get the committee’s approval for his re-nomination for a fifth term as chairman. Greenspan, who is now 78, has served as chairman of the Fed since 1987, under four presidents. But with Greenspan’s confirmation widely expected, attention quickly turned to the news of the day: Concerns about inflation and a possible hike of interest rates. When he was asked about inflation and the state of the economy, here is what Alan Greenspan had to say.
ALAN GREENSPAN: Our best judgment is that the economy is growing in a solid fashion, that to be sure underlying unit costs having gone down for quite a long period have now started to turn up modestly. But our general view is that inflationary pressures are not likely to be a serious concern in the period ahead.
RAY SUAREZ: The Fed chairman went on to indicate that the Fed was leaning toward a moderate increase in short-term interest rates when it meets at the end of the month. It would be the first rise of that rate in four years, which has stood at 1 percent, a more-than-40-year low.
A closer look now at what’s behind the rise in inflation and the debated wisdom of how Alan Greenspan is handling that and other economic matters. Jeff Faux is founder and distinguished fellow at the Economic Policy Institute. And David Jones is chairman of investors’ security trust company, and the author of the book, “unlocking the secrets of the fed.” Jeff Faux, do you share Alan Greenspan’s concern in the near term about inflationary pressures?
JEFF FAUX: I don’t think there’s much of general inflationary pressure in this economy. And I think it would be a mistake for the chairman and the Fed to raise interest rates. These are very serious actions.
We already have plenty of slack in the labor market. We have a 1.3 million more people out of work now than were out of work in March 2001. Probably we could employ another 5 million people in this country before we reached full employment. The industrial capacity numbers show that we’re not near capacity in terms of manufacturing. And so, and there’s no wage pressure. So it’s hard to see what the argument is for raising interest rates now, which will slow down the economy if they’re effective, and if they’re not effective then what’s the point?
RAY SUAREZ: David Jones, do you agree with that analysis?
DAVID JONES: No, i don’T. I think the Fed chairman is right on the mark, and i do expect a measured rate hike at the end of this month, the beginning of a series of small rate hikes. Remember we’ve been working at a rate that’s 1 percent in terms of the Fed target, that’s the lowest in 46 years, i was almost an emergency rate that the Fed put into effect because we had such a weak economy in 2001 and 2002.
Now we’re in the range of growth of 4 to 5 percent, that’s a very solid performance as the Fed chairman says. We’ve created almost a million jobs in the last three months. And there’s just a hint, no more than a hint, on the horizon that perhaps underlying inflation is picking up a little bit. So it’s only prudent for the Federal Reserve to start a series of small rate increases. I would emphasize, though, that it’s a delicate balancing act between keeping inflation in check and being sure the economy stays on an expansion track.
RAY SUAREZ: Jeff Faux just suggested that we’re getting that growth with still a lot of the work force not being used, a lot of the productive capacity not being used, and a low Consumer Price Index number that came out for this month.
DAVID JONES: Well, the problem is you have to look ahead in terms of Fed policy. It usually takes six to twelve months before anything the Fed does begins to impact the economy. So looking ahead a year and with the prospects for continued solid expansion, i think by the time, by this time next year if the Fed did nothing there would be a danger that we’ve seen too much demand in the world and higher inflation. Remember it’s not just the U.S. economy that’s growing, but so are other economies around the world in Asia, and to some lesser degree Europe. All of that demand by a year from now could give us inflation unless the Fed begins a modest process of hiking interest rates.
JEFF FAUX: I think we should learn from the lesson of the 1990s. At the beginning of the 1990s, the conventional wisdom was that we couldn’t get the unemployment rate below 6 percent without igniting inflation. And then the conventional wisdom was 5 percent. We got the unemployment rate down to 3.9 percent at the end of the 1990s, with no inflationary pressures. So there is still plenty of room in the economy, and the problem here is that if we start to slow it down now, we do two things.
One, jobs will not be created that should be created. Wages will not be raised that should be raised. And the second thing is the international economy. We need a low value of the dollar in order to compensate for the fact that we have got this tremendous trade deficit. Raising interest rates means raising the demand for dollars, raising the demand for dollars means raising the price of dollars, which makes it harder to sell our goods abroad, and makes it easier for foreigners to sell here. We have a 500 billion dollar trade deficit that we have to deal with, and raising interest rates and raising the dollar is certainly not the answer to that.
RAY SUAREZ: David Jones, that core rate of inflation, the CPI increase with food and energy prices removed, was pretty low — .2 percent. Why does that signal to you that even down the road we have to be prepared for worse inflation ahead?
DAVID JONES: Well, the year over year growth in that core inflation rate is about 1.7 percent. To be sure, that’s still within the Fed’s unofficial range for price stability, which is somewhere between 1 and 2 percent. But those core inflation rates have been accelerating.
One of the things that has been worrying me is whether or not the fuel price increases would spill over into the rest of the economy, particularly with overall demand picking up fairly strongly. The good news is that has not happened yet. The good news is we’re still within a range of price stability. This to me says the Fed can be very cautious in its rate hikes, but as i say, with demands strong, with growth strong, it’s virtually guaranteed that six months to a year from now we will be seeing inflation.
I’m not in any way suggesting there’s unnecessary alarm over inflation, and furthermore I’ll make a small bet that Greenspan is going to be very careful to keep this growth on track. And if there’s the slightest hint that growth is slowing or job creation is slowing, he’ll pause in these rate hikes. So I think it’s a very good environment — inflation picking up only gradually, economy growing strongly, jobs being created, and the need for no more than modest rate hikes, it’s a good combination that should help the stock market.
RAY SUAREZ: But Jeff Faux, to use history as a guide, you think that Alan Greenspan did pretty much the same thing the last time we were faced with this?
JEFF FAUX: Well, there were two moments in the 1990s when Greenspan moved to raise interest rates too fast. One was in 1990-1991, and George Bush’s father blames Greenspan for having triggered a recession that cost him the White House. And then in 1994 and 1995, Greenspan raised rates too fast, and growth slowed down. Again, this is not an abstraction; this means people out of work, this means people not getting job opportunities.
What we learned in the 1990s is that we could grow a lot faster and when we grow a lot faster, finally people at the bottom of the wage ladder begin to get raises, begin to get jobs, and opportunities are created. So i think that Greenspan is being not cautious enough in and the Fed is not cautious enough if it moves to raise interest rates. A quarter of a point is not going to destroy the economy. But it is the wrong direction when we still have a lot of people that we have to put to work.
RAY SUAREZ: David Jones, speak to that point — the last times that the country faced this same macro economic situation. Alan Greenspan has been Fed chairman for so long that he was around for the last two times.
DAVID JONES: Well, one very important point to make is the Fed chairman presided over the longest peace-time expansion on record from 1991 to 2001– a ten-year economic expansion. Normally in the post World War II period they’ve only lasted four years. That 1994 experience, i would argue, was a mid course correction. We were starting to see too much inflation, Greenspan in a very deft way was able to tighten, then pull back and ease some and keep that expansion on track. So one of the legacies i would say that Greenspan is leaving us is the ability to be able to fine tune the economy in a way that kept that expansion on track for ten years – a feather in his cap –
RAY SUAREZ: You said — don’t you anticipate that he’s going to be confirmed and in your view should be confirmed?
DAVID JONES: Absolutely. He will be confirmed, i think, chairman of the Banking Committee said he’ll fly through in terms of the confirmation process, and he certainly deserves it.
RAY SUAREZ: Do you agree?
JEFF FAUX: I think we ought to take, i think the Senate and the country ought to take a good look at this. Greenspan has been here for quite a while. He’s made some mistakes. He’s also made some political mistakes.
When, this present president was elected in January of 2001, when he took office, Alan Greenspan supported George Bush’s tax cuts, which have started us down the road to a long-term deficit and debt problem that we’re going to have to pay a lot to get out of. Greenspan is supposed to be the person of fiscal rectitude. He’s supposed to be the one who worries about the budget deficit and the debt of the country. And he abandoned that in January of 2001. And I think that had he not, Bush probably would not have gotten that tax cut through, and he certainly wouldn’t have got the, wouldn’t have done the long-term damage to the federal budget and to our debt situation that he’s done. So I think that Alan Greenspan has some things to answer for.
RAY SUAREZ: There’s only time for a very quick response, David Jones.
DAVID JONES: The simple answer is that cuts in tax rates together with low interest rates have given us this strong economic expansion we’re in. We have to worry about the deficit long-term, but the deficit was absolutely necessary to give this growth in the economy a boost, and again Greenspan was giving the right advice.
RAY SUAREZ: Gentlemen, thank you both.
JEFF FAUX: Thank you.