Who Needs the Fed to Fight Inflation?

Funny thing. A real inflation threat emerged this past summer, and guess who dealt with it? Not the Federal Reserve. Not the exalted Alan Greenspan. Nope. The threat was from oil. And the guy who put it down -- at least for the moment -- was the President, Bill Clinton.

Clinton did it by releasing oil from the Strategic Petroleum Reserve -- 600 million barrels tucked away for use in case of need. Did he do right? Absolutely. Sharp increases in oil prices are seriously destabilizing -- a recession threat. They cut real incomes, consumption, business investment and employment. On top of that, they show up in the Consumer Price Index. By acting when he did, Clinton pre-empted that, and gave our slowing economy a breather.

No one noticed, but Clinton's action undid 20 years of myth-making about fighting inflation. This was supposed to be the Fed's job, alone. Remember? "Inflation is always and everywhere a monetary phenomenon." So wrote Milton Friedman. But the fact remains that when the crisis came, a politician took over and sent the Fed to the sidelines.

It served them right, too. The Fed has been "fighting inflation" for many months now, by steadily raising interest rates. Did this stop the rise in oil prices? Not one bit. Did the Fed see the oil danger on the horizon, warn of it, or take any other action? Not in the least.

Instead, all through this expansion, the Federal Reserve has focused its inflation anxieties on the threat of tight labor markets -- on rising wages. But wages have never been, in this expansion, an inflation risk. And they are not the inflation risk today. Clearly, we don't need the Fed to fight an oil shock. But then -- what kind of inflation do we need the Fed to fight? Commodity prices? Why not handle that risk the same way we handle the threat of an oil shock: by building prudent stockpiles and reserves?

And if we can fight commodity prices by such direct, sensible, efficient and harmless means, how about the threat of wage-led inflation -- remote though it is?

Sure. Wages don't go up on their own. They cannot push up prices unless workers actually push wages themselves up too much. And workers -- unlike barrels of oil -- are people. You can talk to them.

Why not try it? Why not enlist America's workers in a bargain? Let's keep wages under control, overall, by raising them some at the bottom, where labor is short, but not so much at the top. And let's enjoy continued full-employment prosperity and an expanding social sector: education, health care, and research, transportation, housing, and -- oh, yes -- oil efficiency and conservation. When we get that deal, we can retire the Fed from fighting inflation. They weren't doing a proper job of it, anyway.

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James K. Galbraith is author of Created Unequal: The Crisis in American Pay (Free Press, 1998) and director of the University of Texas Inequality Project. A professor at the University of Texas at Austin and senior scholar at the Levy Economics Institute, he worked for many years on the staff of the House Banking Committee, where he conducted oversight of the Federal Reserve. He welcomes your feedback and invites you to send it to James K. Galbraith .