NCPA - National Center for Policy Analysis

Some Economists Want Fed To Hike Interest Rates Now

May 7, 2002

It's a suggestion to make a supply-sider gasp: the Federal Reserve should raise interest rates and do so now.

Anti-inflation watchdogs agree with supply-siders that Fed monetary policy was unduly tight -- but they are warning that more recently the Fed has erred on the side of over-inflation.

  • They dispute the notion that the nation did not experience a recession last year, contending that excluding government spending, the economy contracted in all four quarters of 2001 -- explaining the drop in corporate profits and loss of 1.8 million jobs.
  • They blame that contraction on excessively tight Fed policy: the Fed raised interest rates in 1999 and 2000, increasing the federal funds rate to 6.5 percent, while inflation remained stable at near 2 percent.
  • As a result, the real fed funds rate rose to 4.5 percent, its highest level in 10 years.

The same indicators that forewarned of recession 16 months ago -- such as gold prices and the exchange value of the dollar -- now indicate an excessively easy monetary policy. If the Fed maintains this policy for too long, inflationary pressures will begin to build.

Furthermore, these experts say, forces other than Fed monetary policy could undermine confidence and slow economic growth. Those include Enron and Arthur Anderson, steel and lumber tariffs and potential retaliation from our trading partners, exploding government spending, the Middle East, terrorism and oil prices.

Using Fed policy to offset forces it can't control would be a huge mistake. That is what the U.S. did in the 1970s, when the Fed kept rates too low in an attempt to keep an over-taxed, over-regulated economy moving. The result was stagflation.

Price stability -- not economic stimulation -- should be the Fed's goal. The longer the Fed holds down interest rates artificially, the worse inflationary problems will become, they argue.

Source: Brian Wesbury (Griffin, Kubik, Stephens & Thompson), "Hike Rates Now," Wall Street Journal, May 6, 2002.


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