June 16, 2006

TOO MUCH LIKE GREENSPAN, NOT ENOUGH LIKE HIMSELF:

Policy Wonks Versus Bernanke (Jessica Holzer, 06.16.06, Forbes)

[W]ashington economists don't see the threat of prices spiraling out of control, and thus are perplexed by the notion that aggressive tightening by the Fed is necessary.

"We have a strong growth economy with very little inflation--remarkably little considering what's happening to oil," says Alice Rivlin, the vice chair of the Fed's board of governors from 1996 to 1999 and a scholar at the Brookings Institution in Washington.

The economy doesn't have the ingredients for runaway price increases, argues Allan Meltzer, the founder of the Shadow Open Market Committee, a group that tracks Fed policy, and a visiting fellow at the American Enterprise Institute. Money growth is slow, unit labor costs are falling and productivity growth is barreling along, he points out. "There isn't a sign of a long-term inflation problem."

On this score, the Washington experts see eye to eye with high-strung investors, who aren't gripped by inflation fears either. On Wednesday, the Labor Department reported that core inflation, as measured by the consumer price index, rose by 2.4% over the past year--well above the Fed's 1% to 2% comfort zone. Yet the Dow surged 110 points.

Meanwhile, the market for precious metals, which are often used to hedge against inflation and have enjoyed a recent boom, is softening quite dramatically. After peaking in March, prices have fallen off between 24% and 37%.

"It's not 'fear of inflation' that spooked the markets on June 5 but fear of the Fed," says Reynolds.

The Fed has a history of tightening too far, especially when there's a new guy in charge who is trying to prove his inflation-fighting mettle. Some critics argue that former Fed chief Alan Greenspan helped to precipitate the stock market crash of 1987 by airing his inflation concerns and raising the discount rate, a lesser-used tool that the Fed uses to guide interest rates.

A look at the historical numbers should dispel Bernanke's inflation fears, points out Reynolds, who argues that an annual inflation rate of 2.4% is near record lows. Before 1998, it had never been that low, and it averaged 4.7% from 1967 to 2005.

"He may be looking at the wrong numbers or he's not looking at them in the proper historical perspective," says Reynolds.

Posted by Orrin Judd at June 16, 2006 2:21 PM
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