Inflation Terminator

By GEORGE J. CHURCH

By raising interest rates, Federal Reserve Chairman Alan Greenspan is: a) murdering the nation's economic recovery in order to satisfy a monomaniacal obsession with an inflation problem that does not exist; b) driving a timely stake through the heart of the inflation vampire before it can escape from its tomb; c) doing too little too late to prevent an imminent resurrection of ravaging inflation; d) taking action too mild to have much effect of any kind.

While that may sound like a multiple-choice test for economics majors, anyone interested in the future of jobs, prices and incomes has a stake in which answer turns out to be the correct one.

The answer least heard of late is d). True enough, the increase engineered by the Fed in February -- a boost in the short-term rate from 3% to only 3.25% -- was still low by historic standards and applied only to the federal funds rate on loans from one bank to another. But even that modest move sent stock and bond markets into a tizzy, largely because the boost was the first after a five-year fall in borrowing costs. Moreover, the almost universal assumption % is that Greenspan, having reversed course, probably will not stop there.

The chairman himself made that quite clear in congressional testimony last week. In his patented, reassuring drone, Greenspan asserted that prospects for solid growth with low inflation were "the best in decades." Asked what then was the "basis" for raising interest rates, he went off into a flight of circuitous verbosity remarkable even for him. Roughly translated, the chairman's answer meant: cheap credit eventually fuels inflation, and the economy is strong enough now that it can stand a move back to higher rates. There would be more raises, he implied. It was simply a matter of how many, how soon and how large.

Some history: in 1988-89 a Greenspan-led Fed boosted rates 11 times in 11 months. Nine raises were quarter-pointers -- just like the recent one. Would a rerun be wise, especially since a tough recession followed those increases? That brings up two other questions:

-- How real is the threat of renewed inflation? "The same people who worry about inflation saw Elvis a couple of weeks ago," quips New York economist Robert Brusca. Consumer prices last year rose a mere 2.7%, the second smallest increase in the past 18 years; Greenspan himself predicts only 3% this year. Unit labor costs, a prime indicator of future price increases, are going down. Critics think Greenspan is either pursuing a wildly unrealistic goal of zero inflation or following a simplistic syllogism: as a rule, rapid rises in output eventually bring inflation; production grew at an annual rate of 5.9% at the end of 1993; therefore inflation threatens.

Greenspan's supporters see real signs of incipient inflation: recent rises in sensitive commodity prices; delays in deliveries of goods, which suggest tightening supplies that might enable some sellers to make price increases stick. Such pressures will abate, they think, if the Fed makes clear that it will raise interest rates enough to deprive inflation of the tinder of cheap loans. A few economists are worried that the Fed already has pumped too much money and credit into the economy. In their view, Greenspan should have raised interest rates earlier and more sharply than he has.

-- Will higher rates kill the recovery? On the contrary, says Greenspan, they will prolong it. Small increases now will prevent inflation without hurting what increasingly looks to be a sturdy economy. Holding off would allow inflation to blossom eventually and force much bigger interest-rate increases that really would stop growth. But others contend that low rates are the biggest reason why a disappointingly slow recovery has finally quickened into a promising advance. Raising borrowing costs now, they fear, will choke off the budding boom, in part by making purchases of such things as houses and cars harder to finance. Republican Congressman Toby Roth of Wisconsin complained to Greenspan last week, "Many of us feel that you're taking away the punch bowl as the guests are still taking their coats off." But Fed officials liken early moves against inflation to taking away the punch bowl before the party gets out of hand.

Whoever is right will probably be put to a test by further Fed moves. The Clinton Administration, though dedicated to low interest rates, hopes that the rate increases will extend the recovery right into the fall of 1996; it merely expresses hope that the Fed will not raise rates too much. As Roth told Greenspan, "I think all of us in Congress realize that you have more power over the economy than we do." And more than the President too.

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CREDIT: [TMFONT 1 d #666666 d {Sources: Federal Home Mortgage Corp; Federal Reserve}]CAPTION: At This Rate . . .

With reporting by Julie Johnson and Adam Zagorin/Washington and David Seideman/New York