NCPA - National Center for Policy Analysis

Federal Reserve Should Ignore The Monetarists

March 23, 1998

The price of oil has reached a 12-year low of about $13 per barrel. A year ago the price was over $20 per barrel and in 1981 it was over $35 per barrel. Historically, the sharp rise in oil prices during the 1970s undoubtedly contributed to double-digit increases in the Consumer Price Index.

However, some economists recommend that the Federal Reserve tighten credit and raise interest rates to control inflation. Lower energy prices, they say, are simply obscuring the fundamental inflationary forces that are still at work. The true cause of inflation is growth of the money supply, which they believe is presently too fast for price stability.

The idea that money growth is the sole cause of inflation is known as monetarism and in principle it is right. The problem, however, is that there is no way of knowing exactly what rate of growth of the money supply is correct. Economic growth, investment, labor supply and the demand for money are just a few of the variables that can make some particular money growth rate inflationary at one time and deflationary at another.

Determining the right noninflationary monetary policy involves looking at many variables, not just the money supply. Today, most of these other variables are signaling lower inflation, not higher inflation. In fact, the National Association of Business Economists has lowered its estimate of inflation in 1998 from 3 percent a year ago to just 2 percent today (see figure).

The monetarists are still fighting the inflation of the 1970s -- and ignoring evidence contrary to their position. Following their advice would risk a recession. The Federal Reserve should reject it.

Source: Bruce Bartlett (senior fellow, National Center for Policy Analysis), March 23, 1998.


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