- The Washington Times - Monday, March 28, 2005

One of the least-asked questions in government circles today is whether the Federal Reserve Board’s aggressive interest rate increases will weaken George W. Bush’s economic recovery.

Once again, we may be seeing the Fed overreacting to its myopic and exaggerated inflation fears, as it did at the beginning of the 1990s. That led to a temporary, though needless, economic slowdown, helping the Democrats win back the White House.

Last week’s one-quarter of a percentage point increase in a key lending rate, the seventh since Fed Chairman Alan Greenspan began his rate-raising campaign last June, pushed the short-term rate up to 23/4 percent. That’s still low by historical comparisons, but forecasters say it will eventually rise to 5 percent or more, a ham-handed level that could needlessly slam the brakes on an economic expansion still in its infancy.

Mr. Greenspan argues the rate increases are needed to prevent rising inflation from hurting the economy. But too many rate increases to raise businesses’ credit costs could hurt the economy even more. Fine-tuning the economy this way is dangerous, a bit like 18th-century bloodletting. If the patient is bled too much, he weakens and dies.

That raises this question: Is inflation really so bad it threatens to undermine the economy? There are those who say it is not — that the core rate, minus always volatile oil and food costs, is relatively tame. And, in a growing economy, higher prices are also a sign of increased prosperity, rising demand and faster economic growth.

The Consumer Price Index, the most closely watched measure of price inflation, jumped 0.4 percent in February. But consumer prices didn’t rise at all in December and ticked up by a barely moving 0.1 percent in January.

Even so, the Fed’s statement last week said, “Pressures on inflation have picked up in recent months,” adding businesses’ ability to raise prices has become “more evident.”

There were sharp increases in oil, in response to growing worldwide demand, but also for air travel, health care and college costs. Yet when energy and food prices are excluded, the core inflation rate in February was 0.3 percent. That core rate has risen 2.4 percent over the last 12 months, not an excessive rate in a growing economy dealing with pent-up demand in housing, cars and other consumer goods.

But even the Fed acknowledged the oil price increase — one of the largest factors in the CPI uptick — “has not notably fed through to core consumer prices.” Nor has it had much if any effect on metals and other commodities in the manufacture of autos and other durable goods.

University of Maryland economist Peter Morici, among others, thinks there is no reason to fear we are at the beginning of an inflationary spiral. He cites a number of offsetting factors.

“There is no reason to panic, as productivity growth remains strong and wage pressures are weak. Productivity growth and unemployment above 5 percent will continue to restrain prices going forward,” he said last week. Moreover, “manufacturers have been able to absorb much of the increased costs of materials, and retailers have been able to absorb much of the increased cost of goods sold, by saving on labor,” he said.

Good points that are missing in the Fed’s “sky-is-falling” arguments and fears about runaway inflation, and that are being ignored on Wall Street, too. The U.S. economy over the last decade has been getting lean and mean on cutting costs and increasing productivity, thus lowering per-unit costs of production, which, in turn, allows companies to hold down or even reduce prices, making them more competitive.

“Dramatic improvements in U.S. productivity continue, as advances in manufacturing, new materials, supply chain management, and information technology continue to spread through the economy in the most fortuitous ways,” Mr. Morici reminds us. “These advances increasingly insulate the U.S. economy from commodity driven inflation.” That’s why he thinks “inflation will stay manageable” and the Fed “should continue on a moderate course to return monetary policy to a neutral position. There is no need for more abrupt action.”

I agree. Perhaps there will be more increases in oil, gas and other energy costs as global demands rise, reflecting fast-growing economies in China, India and elsewhere in Asia. But the U.S. economy has shown it knows how to control its costs and keep pricing within competitive levels.

Besides, the dubious and dismal science of managing inflation through interest rates is woefully outdated. The marketplace is much more efficient now at keeping the lid on inflation.

With higher oil prices raising the costs of doing business, now is not the time to raise the costs of borrowing, too.

Donald Lambro, chief political correspondent of The Washington Times, is a nationally syndicated columnist.

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