- The Washington Times - Sunday, June 13, 2004

Near the beginning of a speech delivered last week to the International Monetary Conference in London, FederalReserveChairmanAlan Greenspan reported that “concerns of deflation [are] now presumably behind us.” He later candidly warned that he did not intend to ignore the evolving dangers of another threat.

At the close of his speech, Mr. Greenspan repeated the view that the Fed’s policy-making committee revealed following its last meeting: “[M]onetary policy accommodation can be removed at a pace that is likely to be measured.” But he immediately pointed out that such a conclusion was based on the Fed’s “current best judgment” of how the economic and financial forces evolve in the months ahead. At the very end of his speech, Mr. Greenspan asserted, “Should that judgment prove to be misplaced, however, [the Fed] is prepared to do what is required to fulfill our obligations to achieve the maintenance of price stability so as to ensure maximum sustainable economic growth.”

The unmistakable implication was that the Fed was not prepared to allow inflationary expectations to race ahead of policy measures enacted to dampen them. The warningshouldbewelcomed.Mr. Greenspan specifically referred to the upward trend in the Fed’s favored inflation gauge, the core personal consumption expenditure (PCE) price index, which excludes the volatile food and energy sectors. Measured over 12-month periods, the core PCE index, he observed, has increased from 0.8 percent in December to 1.4 percent in May. (Adding to the concern, no doubt, was the recent behavior of the core consumer price index, whose annualized rate of increase over the February-April period reached 3.3 percent.) Beyond the core index, however, the Fed chairman noted that “the persistence of the rise in energy prices” had become “worrisome.” Should the recent higher oil prices persist, he warned, they would likely “boost core consumer prices as well as the total price level.”

History instructs that Mr. Greenspan is right to be concerned about the economy-wide impact of rising energy prices. Price indexes that exclude energy clearly have their place in gauging underlying inflationary trends. However, the failure to fully appreciate in a timely manner the ability of persistently rising energy prices to feed into higher prices of other goods has repeatedly led to bad economic consequences throughout the post-World War II period. Economist James Hamilton, who has studied the relationship between increases in world oil prices and the U.S. business cycle, has found that rising oil prices have preceded nine of the 10 recessions since 1947.

Given the recent explosion in world energy prices and the seeming sustainability of the acceleration of economic growth throughout the world, particularly in the United States and Asia — including, thankfully, Japan — Mr. Greenspan was wise to alert the markets that the Fed understood its obligation to “achieve the maintenance of price stability.” Failure to do so would indeed jeopardize the ability to “ensure maximum sustainable economic growth.”

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