November 23, 1994
"Alan Greenspan has His Reasons"
San Jose Mercury News
By Timothy Taylor
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IF THE Federal Reserve had any lingering hopes of winning a popularity contest
during 1994, it ended the fantasy by raising interest rates again last week. To
hear people talk, the Fed apparently opposes economic growth, supports unemployment,
and wants to raise the monthly payments on my adjustable mortgage.
Actually, the Fed's action only illustrates a more prosaic lesson: Policies
that bring long-term economic health are often unpopular at first.
It takes a remarkably short memory to believe the Fed supports high interest
rates. This very same Fed chopped the "federal funds" rate -- the same
rate it has been increasing this year -- from 9 percent in late 1989 to only 3
percent in late 1992.
Fed Chairman Alan Greenspan and more or less the same crew are still in charge.
They haven't changed their economic theories. What has changed is the shape of
Unemployment was rising in the early 1990s, going from 5.5 percent in 1990
to 7.4 percent in 1992. The economy was in recession, and inflation was falling
from 5.4 percent in 1990 to 3 percent in 1992.
Today, unemployment has declined to 5.8 percent, the economy has been growing
for more than two years, and while inflation hasn't started up, yet, pressures
are bubbling near the surface.
The lower interest rate policies that made sense in the early 1990s are not
appropriate for the very different economy of today.
Of course, higher interest rates are never much fun. I hate to see the monthly
payments rising on my adjustable mortgage.
But if inflation gets rolling again, those payments could go through the roof.
Remember, fears of inflation drove mortgage interest rates above 10 percent as
recently as 1989 and 1990, and as high as 14 and 15 percent in 1981 and 1982.
Even if I have to pay more in the next few months, I'd rather have Greenspan and
Co. push up interest rates right now to nip any resurgence of inflation in the
Others feel more concern that the Fed is strangling economic growth and unemployment.
But growth and employment are very different things.
For example, unemployment in Western Europe has remained stubbornly above 10
percent in many countries, right along with steady (if unspectacular) economic
growth. Or in the United States, the economy has grown by about 12 percent (after
adjusting for inflation) since 1988 -- yet unemployment remains slightly higher
today than it was in 1988.
Economic growth may simply mean that the present workers are being more productive,
while the unemployed remain out of the picture.
The Federal Reserve has limited power to fight unemployment. It can fight the
unemployment associated with recession, as it did by reducing interest rates in
the early 1990s. But when the economy has been recovering for a couple of years,
the cures for the remaining unemployment are necessarily different.
There is an interesting irony here. Many of the present critics of the Fed,
who tend to be politically liberal, also criticized Ronald Reagan's philosophy
that growing the economy would necessarily help people. As they so often pointed
out, a rising tide doesn't lift all ships. They were right.
But for the same reasons, lower interest rates aren't going to help many of
those who are presently unemployed.
Consider the situation of a mother on welfare, confronted by the problem that
if she starts working and earns, say, $5,000, she will lose welfare benefits worth
$5,000, along with losing Medicaid coverage for her children. Her problem isn't
high interest rates. It's usually a combination of poor job skills, lack of day
care and health care for her children, and the counterproductive incentives of
the welfare system.
Consider the middle-aged middle manager, re-engineered out of a job at a Fortune
500 company. Or consider a student, just coming out of school and looking for
work, but unable to find steady work that offers benefits like health insurance
Again, the issues are not interest rates, and not the behavior of the Fed.
Instead, the policy challenge is to find better ways for people to learn useful
job skills, to design programs to encourage mobility between jobs, and to spread
information about jobs more quickly. It would also help if we didn't keep requiring
business to provide additional fringe benefits, since these tend to push them
into hiring temporary or contract workers, or not hiring at all.
Even President Clinton's two appointees to the Fed's Board of Governors, although
they have not been shy about expressing dissent, supported the most recent rise
in interest rates.
The economy works best as a long-distance runner, showing the endurance to
sustain a healthy pace. By acting to keep inflation stable and low, the Fed is
doing what it can to set the stage for long-term investment and growth.
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