[PEN-L:8306] Economists challenge Fed's inflation 'hunch'

[Robert Naiman <naimanr@xxxxxxxxxxxx>]

The Christian Science Monitor

                             June 21, 1999, Monday

SECTION: FEATURES; WORK & MONEY; CAPITAL IDEAS; ECONOMIC SCENE; Pg.
17

LENGTH: 744 words

HEADLINE: Economists challenge Fed's inflation 'hunch'

BYLINE: David R. Francis, Staff writer of The Christian Science Monitor

DATELINE: BOSTON

BODY:


Economists have had a hard time predicting inflation rates this decade.

"The record hasn't been great," says Dean Baker, an economist with the
Preamble Center, a
Washington think tank.

So the Federal Reserve is taking something of a gamble if it raises
interest rates to slow the economy
in a "preemptive" action against inflation.

The risk is that a rate hike - or hikes - could damage the nine-year-old
economic expansion in the
United States and its accompanying prosperity. It also could clobber stock
prices.

But in testimony to Congress last Thursday, Fed Chairman Alan Greenspan all
but announced that a
"modest" rate hike would be taken at a monetary policy session June 29-30.

To Mr. Baker, the Fed's expected hike in short-term rates of 0.25 percent
to 5 percent would be
based on a mere "hunch" - not any solid predictive power.

In the minutes of a Fed policymaking session of last February, some
participants acknowledged that
they had been constantly surprised that inflation had not picked up as
unemployment steadily
dropped to its present 4.2 percent rate.

Further, in the Fed's semiannual reports to Congress in the last few years,
its inflation predictions
have been too high.

"Fed officials have been pretty clear in saying that traditional methods of
forecasting inflation are not
serving us well," notes Thomas Schlesinger, executive director of the
Financial Market Center in
Philomont, Va.

Mr. Greenspan admitted that guiding monetary policy by its present models
of the economy "would
have unduly inhibited what has been a remarkable run of economic prosperity."

But many in the financial community have great confidence in the judgment
calls of Greenspan.

Both stock and bond prices rose after his strong hint of a rate hike ahead.

"If the goal is to prevent or limit a rise in inflation, since monetary
policy works with a lag, it is prudent
to start imposing some restraint now," says Paul Kasriel, an economist with
Northern Trust Co.,
Chicago.

Even those Fed watchers keen on low interest rates as a way to help
low-income workers win bigger
wage increases praise Greenspan for letting the jobless rate fall so low.

Greenspan's rationale for a preemptive move is that "certain imbalances" in
the economy pose a risk
to the longer-run outlook. But he acknowledged that an acceleration in
productivity resulted in an
underprediction of economic growth and an overprediction of inflation, and
that labor-market
tightness has not yet put the expansion at risk.

"Inflationary pressures still seem well contained," he said.

Nonetheless, he saw a danger that a growing scarcity of workers could
provoke large inflationary
wage gains.

And, he added, because higher interest rates take time to slow the economy,
"we have to make
judgments ... about how the economy is likely to fare a year or more in the
future under the current
policy stance."

In effect, he pronounced a speed limit for the economy of 3 percent growth
in national output after
inflation. But output grew almost 4 percent last year and even faster than
that in the first quarter of
this year.

Those hoping the Fed will not put on the brakes, offer at least three
counterarguments:

1.The lag between Fed braking and the economy slowing is short. So the Fed
can afford to wait for
more inflation to appear.

Some impact of an interest-rate hike takes place in two months, though the
full impact may take 18
months or two years, says Baker.

2.Rapid inflation doesn't spring forth full-blown.

"It grows incrementally," says Mr. Schlesinger. So the Fed has some time to
restrain it.

James Galbraith, an economist at the University of Texas, Austin, says the
Fed could allow the
unemployment rate to fall even further, 0.1 percentage point at a time, and
then see if inflation starts
to accelerate. "Watch what happens," he says.

3.Though there are some signs of recovery abroad, the world economy is
still shaky.

"The US cannot consider itself in isolation," says Gordon Richards, an
economist of the National
Association of Manufacturers in Washington. "It must create dollar
liquidity for the world."

But Greenspan sees inflation as a danger to prosperity. "Our
responsibility," he said, "is to create the
conditions most likely to preserve and extend the expansion."





GRAPHIC: PHOTO: GREENSPAN: The Fed chief hints of a rate hike.
Someeconomists disagree
with the idea. BY JOE MARQUETTE/AP

LANGUAGE: ENGLISH

LOAD-DATE: June 20, 1999
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-------------------------------
Robert Naiman <naimanr@xxxxxxxxxxxx>
Preamble Center
1737 21st NW
Washington, DC 20009
phone: 202-265-3263
fax:   202-265-3647
http://www.preamble.org/
-------------------------------