UPS & DOWNS
JULY 3, 1996
The NewsHour's economics correspondent, Paul Solman of WGBH-Boston, looks at the importance of the role the Federal Reserve plays in the U.S. economy.
PAUL SOLMAN: Well, in simple terms, the Federal Reserve's regular job is regulating the economy, the method of choice in recent year, adjusting short-term interest rates. When the economy grows rapidly, the threat of inflation looms, and so the Fed raises interest rates to slow things down. When growth is too slow, unemployment threatens, and so the Fed lowers interest rates to give the economy a boost. And that at least it the theory. But who in practice is making the key decisions? Actually it's a group of 12 people known as the Open Market Committee, at its head the Fed chairman, at the moment Alan Greenspan, just reappointed by the President to a third four-year term. He has a new vice chairman, Alice Rivlin, former budget director in the Clinton White House. Joining these two are five other members of the committee known as governors. One of them is new, economic forecaster Lawrence Myer. To this standing committee of seven is added another five representing the Fed's regional banks from around the nation. Today this committee met and decided to do nothing. But even that's significant. And here to tell us why and to assess the new Fed is Lyle Gramley, a former Fed governor and now with the Mortgage Bankers Association of America, and Ron Blackwell, chief economist with the Labor Union of Needle Trades Industrial & Technical Employees. Welcome to you both. Suppose for a moment that you are both members of the Fed--you were, after all, a governor of the Fed--and you are meeting today. Would you have agreed with the decision to do nothing? You first, Lyle Gramley.
LYLE GRAMLEY, Former Federal Reserve Governor: I would have been inclined to raise interest rates today. I think the economy is growing too strongly. There are forecasts that the economy is going to slow in the second half of the year, but we don't know that for sure, and we have to be prepared for the possibility. And if the economy grows too fast, the inflation fundamentals are going to start deteriorating gradually. I think we need to avoid that.
MR. SOLMAN: So you're the inflation hawk, the anti-inflation hawk?
MR. GRAMLEY: Right. Right.
MR. SOLMAN: All right. So Ron Blackwell, I assume you being left of the mainstream, that they probably wouldn't give you a seat at the table or yesterday, but if they had, if you had been there, would you have agreed with the decision?
RON BLACKWELL, Labor Union Economist: (New York) Well, I don't think it's so much about being left of center, Paul. It's really about representing the vast majority of American families. As we like to say in the American labor movement, America needs a raise, and America hasn't had a raise for the 20 years in which wages have been falling, and that's partly because the economy is not growing fast enough. It's only growing at 2.5 percent or 2.2 percent actually on a revised basis, and that's simply not enough to allow workers to participate in increased productivity by seeing their wages rise.
MR. SOLMAN: So you mean you think the Fed has been holding back the potential for growth in the economy?
MR. BLACKWELL: Oh, I think there's no question about it. The Fed should have the mandate of assuring two things: one is rapid growth in employment, and the second thing is price stability. But the Fed under its current leadership is pursuing only one of those objectives, which is price stability. And it defines that rather narrowly to mean gradual progress towards zero inflation. There is no sign of any price pressure anywhere, and there's no excuse for requiring that the economy grow at the meager rate that it's currently growing. You've got to realize that, that this is in the fifth full year of this economic recovery, and wages are still falling. There's no sign of price pressure anywhere. There's certainly no sign that wages are pushing prices up. Wages are still falling. We need to see more growth, and we were certainly relieved that the Open Market Committee decided not to take any action today, but we would prefer to see them cut rates by as much as 1/2 percentage point, and get the real growth rate above 3 percent.
MR. SOLMAN: So if you had been there today, you would have voted for lowering rates?
MR. BLACKWELL: That's right.
MR. SOLMAN: Okay. So Mr. Gramley, are you shocked to hear this? How do you--how do you assess this great difference of opinion?l MR. GRAMLEY: I certainly understand where he's coming from but when we think about how fast our economy can grow, we have to look at what I think are the facts. What we mean by economy's long-term potential growth rate is the rate of growth which keeps the unemployment rate constant. You don't have to be a statistician or an economitrician or even an economist to figure out what that is. All you need to do is take two points in time fairly far apart with the same unemployment rate, and measure the growth rate of real GDP over that interval.
MR. SOLMAN: So you mean the growth of the economy over that period of time, so unemployment would be the same.
MR. GRAMLEY: Right.
MR. SOLMAN: And you're saying it's about 2 1/2 percent?
MR. GRAMLEY: It's lower than that. From the third quarter of 1990 to the third quarter of 1995, two quarters in which the unemployment rate was 5.6 percent, the economy grew at an annual rate of 2 percent. So our long-term, potential growth rate unfortunately is only about 2 to 2 1/4 percent at best.
MR. SOLMAN: And that's the argument you would make if you were sitting there, I take it?
MR. GRAMLEY: Yes.
MR. SOLMAN: And you would look at data.
MR. GRAMLEY: That's one of the arguments I would make, and the other is that in the second quarter, our economy is going to be growing at an annual rate of over 4 percent, and that could well continue, we could well continue to see growth in excess of our long-term growth potential in the second half of the year.
MR. SOLMAN: And when that happens, then inflation--
MR. GRAMLEY: Then inflation might well begin to move up.
MR. SOLMAN: Okay. So Ron Blackwell, he's afraid of inflation. He looks at the long-term growth rate, but you were just talking about that same period of time and saying that it was anemic growth during that period of time.
MR. BLACKWELL: Absolutely. I think Dr. Gramley, it seems to me, is fighting the inflation wars a quarter century ago. Admittedly those were very serious in the late 60's and the early 70's, when we had both very high unemployment and very high inflation, but that was a long time ago, and the current picture economically looks more like the 1950's than it does like the 1970's. And like I said before, when economists like Dr. Gramley were, were predicting what the natural rate of unemployment was a year or two ago they would say 6 to 6 1/2 percent. We're well under that. We've been under that for a long time. Again, there's still no sign of inflation, but we do have a million more workers back at work, earning a living for their families. There's no reason to believe that 2.5 percent rate of growth is the speed limit in the American economy. If during the earlier period when Dr. Gramley--if the problem then was inflationary expectations on the part of workers, the problem today is deflationary expectations on the part of the bond traders. And I think both are unhealthy conditions.
MR. SOLMAN: Well, now, I mean, he's talking about something that a lot of people have talked about on this show, he's talked about it before on this show, which is this notion that unemployment is simply--can go a lot further. It's not--we're not playing by the old rules, and we've seen no sign of inflation igniting when unemployment has gone down to a level that you, yourself, when we once talked, said it couldn't go below.
MR. GRAMLEY: I think we have to acknowledge that our full employment, unemployment rate is lower today than it used to be. There are a number of reasons for this. Two of the most important ones are the fact that we don't have any inflationary expectations anymore. We're--
MR. SOLMAN: So you think--the Fed, itself--
MR. GRAMLEY: The Fed, itself, is benefiting from its own success. The other is global competition, which is acting as an important disciplinary force on inflation. But that doesn't mean we can grow as fast as we want to forever. If we were well below the--well above the unemployment rate, which is consistent with price stability, then you would expect to see prices continuing to decelerate, inflation to decelerate. It's not. We're enjoying price stability for the past three years.
MR. SOLMAN: Now, give us a sense of what actually goes on for a second. You're sitting in that room for two days and people are--is there secret data that the public doesn't get?
MR. GRAMLEY: No.
MR. SOLMAN: I mean, the famous William Brider book was Secrets of the Temple about the Fed. I mean, do they know stuff that we don't know? What do you hear?
MR. GRAMLEY: Unfortunately, they have the same information that we do. They perhaps have a better source of anecdotal information on what's going on in the various parts of the country coming from the regional reserve bank presidents who participate in the meeting, but that the statistics they use are the same ones that we all have.
MR. SOLMAN: So they just--they just go about their business the way we're forecasting here--
MR. GRAMLEY: Exactly.
MR. SOLMAN: --and they make that same, same kind of thing.
MR. GRAMLEY: Exactly.
MR. SOLMAN: In terms of sort of this new group, what's your take on that, Ron Blackwell? You've got a couple of democratic employees--appointees. Do you think they're going to tilt more in your direction, loosening the economy? We heard some talk of that with Alice Rivlin becoming the vice chairman of the Fed.
MR. BLACKWELL: Well, it's hard to say, and we certainly hope so, but we'll only know as time goes forward. Unfortunately, though, the conventional wisdom among economists, and I think even among the recent appointees, is that the natural rate of unemployment is somehow prohibiting the economy from growing faster than it is, and, therefore, they won't be dissenting voices on the fundamental policy direction of the Federal Reserve Bank.
MR. SOLMAN: When you say the natural rate of unemployment, you mean the rate at which--
MR. BLACKWELL: The rate at which according to the theory of the people at the Fed inflation will accelerate and accelerate without limit.
MR. SOLMAN: That's the point below which you can't go without bad consequences.
MR. BLACKWELL: But as Dr. Gramley just pointed out, he used to say it was 6 to 6 1/2 percent, we're well below that, there's no sign of any such acceleration of inflation. I don't accept that theory at all, but most economists do, and I think the current appointments also accept that idea. I would hope that they would be slower to put the brakes on the economy, and I'd hope they'd be quicker to recognize weakness in the economy and lower rates in response. But I don't think the new appointments--I hope I'm disappointed--but I don't think they will fundamentally differ from the conventional wisdom at the Federal Reserve Bank. I might also point out that there's a real problem with these regional banks because they are the most inflation hawkish part of this Open Market Committee. These are representatives of the regional banks, and they're not elected by the people. In fact, they're elected by the bankers in their region. And, of course, bankers have a different way of looking at this than working people do, which is why they're satisfied with 2.2 percent or 2.5 percent. They're probably in that 20 percent of incomes, family incomes that have been raising over the past period of time. But if they were sharing the fate of 80 percent of American families, whose families' incomes are stagnant or falling, they might have a different view about what the maximum rate of growth is and about what risks they were willing to accept in order to try to get a higher rate of growth and a higher rate of unemployment growth.
MR. SOLMAN: Now what do you think, Lyle Gramley, is this new group possibly softer on inflation than you'd like? After all, they didn't raise rates, and you would have voted for them to be raised today, right?
MR. GRAMLEY: This is one point on which Mr. Blackwell and I can probably agree fully. These are two mainstream Democratic economists. That's not a term of opprobrium, as it used to be.
MR. SOLMAN: Opprobrium for Republicans such as yourself you mean.
MR. GRAMLEY: They are, are clearly concerned about inflation. They want to get as much output out of the economy in the short run as is consistent with maintaining price stability in the longer run, and I think that'll put them basically in the middle of the stream of people at the Federal Reserve.
MR. SOLMAN: Next August, there's another meeting of the Fed. Do you expect them to raise rates at that time? Does the market expect that?
MR. GRAMLEY: The market expects some increase in interest rates before the end of this year, yes. My expectation would be that if the economy continues to show strength into the third quarter, the Fed will have little choice but to go ahead and raise interest rates in August.
MR. SOLMAN: And are you afraid of that, Ron Blackwell?
MR. BLACKWELL: I'm very much afraid of that. I think, you know, we had this reasonably healthy growth of employment last month, and there was panic in the bond markets and on Wall Street. We really have a divide here again between the people who trade bonds for a living and the people who go to work every day. And I'm afraid that this is a self-fulfilling prophecy where the bond market will demand if there's a healthy growth in the third quarter that they're going to raise interest rates. That's exactly what they shouldn't be doing. We should not be afraid of three or even four percent growth, and it's not forever, and it's not unsustainable. We need healthy growth in order that we can close the current wage gap, allow the majority of American families to make a living in this country, and reduce the growing inequality of income and wealth that is undermining our society and threatening our politics.
MR. SOLMAN: Okay. Well, thank you both very much.