Fed Crying Wolf Over Inflation
April 24, 1997
Fed chairman Alan Greenspan has been warning of increased interest rates to stave off the inflationary pressures of a robust economy -- such as high stock prices, low unemployment rate and higher wages.
However, free market and financial commodity prices show modest levels of inflation over the past year.
- Leading commodity indexes by Goldman Sachs and the Commodity Research Bureau have fallen 10 percent over the past year.
- Figures show gold and precious metals have dropped over 12 percent.
- Even the consumer price index (CPI),which many analysts believe overstates inflation by 1 percent, only registered a mild 2.8 percent increase over the past year, according to latest figures.
So why is the Fed crying wolf over inflation? Economists note some Fed staffers are still using the outdated Phillips Curve to make inflation forecasts, which rigidly assumes a zero-sum tradeoff between unemployment and inflation: if one rises the other falls.
According to economist Milton Friedman, the Phillips Curve has never worked and reminds us that too much money chasing too few goods causes inflation -- not higher employment rates.
- Economists note that in the 1970s rising inflation hurt the economy and caused unemployment to rise.
- Conversely, in the 1980s lower inflation sparked life into the economy and caused unemployment to drop, analysts observe.
From 1985 to 1994 the Fed focused on free-market price indicators to gauge if money was scarce or excessive, with particular emphasis on the movement of gold, broad commodity indexes, the dollar exchange rate and Treasury yield curve spreads.
The "price rule" approach laid the foundation for a healthy economy, with inflation rising only 2.5 percent over the past five years while real GDP advanced by 2.7 percent annually.
Source: Lawrence Kudlow (American Skandia Life Assurance Corp.), "Show Us the Inflation," Washington Times, April 24, 1997.
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