June 6, 1993
"Clinton Nightmare: Inflation Rising From the Grave"
San Jose Mercury News
By Timothy Taylor
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JUST when the vampire of inflation seems safely buried, with a stake through its heart and a garlic necklace, the coffin lid creaks open again.

The warnings sounded a couple of weeks ago, when it was announced that consumer prices had risen .4 percent in April, an annual rate of about 5 percent. Since then, the Federal Reserve and President Clinton have been tussling over whether the figures represent a blip or a trend.

Both sides agree on the obvious: Inflation isn't yet stalking among us. Prices rose just 2.9 percent in 1992; with the exception of 1986, 1992 was the lowest annual rate since the early 1960s. The consensus forecast seems to be for a 3.5 percent inflation rate this year, perhaps 4 percent next year.

It may seem a lot of fuss about 1 or 2 percent, however, the Federal Reserve knows two bothersome facts about inflation.

Even small changes in inflation can make a real difference, especially in long-term economic decisions like saving for retirement or major investments in new industrial capacity. At a 3 percent rate of inflation, for example, the purchasing power of a dollar is cut in half in 24 years; at a 5 percent rate, it takes a bit less than 15 years. Every moment spent trying to protect savings or investments from inflation is time taken away from working on real, productive economic decisions.

Although low rates of inflation are somewhat worrisome, the big fear is that slow inflation may accelerate.

After all, the essence of inflation is a cycle of self-confirming beliefs. Workers demand higher wages because of the increases in prices; employers can pay the higher wages because of the increases in prices. In fact, a time of rising wages and prices may, for a brief period, look good to everyone, before everyone recognizes that they are just riding the inflation treadmill again.

The Federal Reserve has only one cure for inflation: Push up interest rates, which reduces economic demand and thus the pressure for price increases. Once an inflationary cycle is entrenched, this process can be extraordinarily painful. Breaking the back of double-digit inflation in the late 1970s and early 1980s, for example, required interest rates reaching almost 20 percent, and double-digit unemployment.

Rather than allow matters to get so far out of hand, the Federal Reserve is apparently mulling a small, immediate increase in interest rates, to head inflation off at the pass. As Fed chairman Alan Greenspan recently said, "We need to be especially vigilant not to be mesmerized by the current tranquillity of the inflationary environment."

Such comments must send a chill down Bill Clinton's neck. Since the dismemberment of his short-term economic stimulus package by Congress, Clinton's primary tool for giving the economy a short-term boost has been lower interest rates to stimulate business investment and consumer purchases of houses and durable goods. Earlier this year, as Congress made encouraging noises about cutting the budget deficit and the Fed made reassuring noises about inflation being under control, long-term interest rates were dropping.

If the inflation figures for May (to be released in about a week) equal or exceed the April rate, it will signify to the financial markets that inflation is stirring, and that the Fed soon will nudge up interest rates. Clinton will have no tools remaining to give the economy a quick prod.

Some of this inflation boomlet is no one's fault. Severe March storms led to shortages in some parts of the country, which pushed up April prices. After several years of holding the line on price increases, firms in many industries seem to be testing whether some price increases can fly.

But Clinton can't escape blame. New government regulations and burdens on business, and the threat of more, are contributing to price increases.

Also, the Clinton administration has been lobbying for a weaker dollar. This benefits U.S. producers, by making it less profitable for foreign companies to sell in the U.S. (because the dollars earned here are worth relatively less), and by making it more profitable for American companies to sell abroad (because the currency earned abroad is relatively more valuable). However, when imports are offering less competition, inflation often results.

If the Federal Reserve decides to push up interest rates to nip inflation in the bud, Clinton will be sorely tempted to threaten and cajole, to downplay the risk of inflation and stress the need for immediate growth. Such fulminations would be short-sighted.

The last two Democratic presidents, Lyndon Johnson and Jimmy Carter, both left a legacy of rising inflation for their Republican successors to clean up. If Clinton wants to lay a solid foundation for long-term growth, and give the public a reason to believe that Democrats can be trusted to manage this aspect of the economy, he has to show a willingness to take inflation seriously, and to fight it.

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