James K. Galbraith
Have you noticed all the establishment liberals defending the Fed? They have enlisted as Greenspan’s Swiss Guard, brass helmets shining, pikes at the ready. To bash those who would bash the Fed – this has become their holy task. Just last week, George L. Perry of Brookings was quoted, in distinctly theocratic tones:
“There is a tendency to go too far and talk as if we’re in a world where there are no limits and where we don’t need to think in terms of the old concepts at all… .”
Then on the Op-Ed page of The New York Times, I found Alice Rivlin:
“Other critics regard all interest rate increases as pernicious and dismiss the risks to future expansion from incipient inflation, extreme worker scarcity and consumer spending out of paper wealth.”
In my local paper, The New Republic’s columnist Matthew Miller – he used to work for Rivlin — was even harsher:
“The surest test of the Fed-bashers’ confusion (did someone say ‘intellectual corruption’?) is simple: They’ve never met an interest rate hike they can support.”
As to solutions, Perry knows infallibly what must be done: “… we have to tighten monetary policy to slow the economy.” Rivlin calls it a “no-brainer:” “The economy is growing too fast, and the Federal Reserve needs to keep raising the short-term interest rate – the only instrument it has – until the economy slows to a more sustainable pace.” Miller says the economy is growing “far beyond anyone’s guess” of potential, and raising rates is therefore “only prudent.”
Convincing this may sound (did someone say “shrill”?), but recent history provides no support for the slow-it-down prescription. Rivlin concedes this: “… economists used to say that unemployment rates below 5 percent, or growth rates above 3 percent, would cause inflation, but those limits have been breached for some time without ill effect….” Miller, too, confesses: “Nobody knows just how low joblessness can go in this new era without igniting inflation.” (Ergo: Inflation has not ignited yet.) It is, to choose words precisely, a matter of faith.
So let’s take up the various arguments on their merits. Shall we? Here are 9.5 theses for the Brookings door.
1. Is the economy growing too fast? 7.3 percent in the fourth quarter sounds high. But we already have the first quarter numbers: growth slowed to 5.4 percent. In 1984, 7 percent growth rate continued all year, then slowed on its own. In the late Sixties, unemployment was below 4 percent for three years. There was a bit of inflation then – but there was also a war on.
2. Is there incipient inflation today? Rivlin says so, but that was based on the March C.P.I. Producer prices declined in April – a fact already known when she published, but she didn’t mention it. And then consumer price inflation practically disappeared in April too, just before the Fed hiked rates.
3. Why did inflation disappear? Oil prices went down. And productivity growth has been high enough to prevent high actual growth rates from pushing up other costs. When productivity growth keeps up with output growth, there will be, by definition, no inflation problem.
4. Do we have extreme worker scarcity? If so, why aren’t wages rising faster than prices? Unit labor costs rose only 1.8 percent in the first quarter; in the previous two quarters they declined.
5. Should we be concerned about the wealth effect? To quote from Dubya Bush, “Maybe, maybe not.” But if so, short-term interest rates are not the only instrument the Fed has. To cool the tech stocks late last year, it could have raised margin requirements. (Forgive me, dear readers, I have said this before.)
6. Will rate hikes actually slow the economy to a sustainable pace? Sad to say, this has never happened. In the short run, knowing that interest rates will rise, borrowers rush to beat the increases; spending and growth continue to go up, not down. (Same story as in 1994, incidentally.) Eventually there follows a market break, investment slump, and recession. (In 1995 we got lucky: the Fed stopped raising rates before the bad effects took hold. )
7. What would happen next, if the Fed didn’t raise rates? I don’t know. Why not wait to find out? My guess is that the economy would slow somewhat on its own, both output and productivity growth, without accelerating inflation. The slumping stock market and budget surpluses are already dragging down the growth rate, a point Rivlin also concedes. In other words, we will get where Rivlin wants, even if nothing is done.
8. Is it intellectually corrupt to oppose higher rates? Personally I have consistently opposed higher interest rates. I did ask Matt Miller, as a cross-check on his simple test, whether he had ever criticized Fed policy; the candid answer was no. Neither, I’m fairly sure, have Alice or George. But in all cases, though, that’s consistency, not corruption.
9. And come to think of it, who are all these supposed Fed critics? I feel pretty lonely out here most days. Where is Al Gore? Where are the Democrats in Congress? And where is the AFL-CIO? Why are my left-liberal friends wasting themselves on China, while my establishment-liberal friends go heretic-hunting for Greenspan? Why am I forced into a god-help-me alliance with the unrepentant Reaganite supply-sider Larry Kudlow?
9.5. Well, I’ll take Kudlow if I have to. Larry and I know, at least, what higher interest rates will do, unless this campaign stops soon. We both lived through it in the Reagan years. The long-run effect of a continuing campaign to raise rates is not sustainable growth but recession, with rising unemployment, mass bankruptcies, and a return to big deficits. This happened in 1970, in 1974, in 1980, in 1981—82, and in 1990.
The hard fact is, these folks crash land just about every single time. And that is the real reason why we heretics oppose the Fed’s policy. We have looked at history. And we oppose a course of action that has almost always, in the past, led to disaster.
James K. Galbraith believes in full employment, balanced growth, reasonable price stability, low interest rates, and the great Ogden Nash couplet: “if there is one virtue to Americans unknown, it is: leave well enough, alone.” This piece ran first in TheStreet.com.