9.5 Theses for the Brookings Door came under fire, I notice, from
James Padinha. Herewith a return of fire.
1. Why do I use real growth rates?
Because the speed-limit argument is always about the rate at which
resources can be brought into
production. It is about the pressures that too rapid
economic growth may or may not put on prices. A discussion of whether any growth rate is sustainable makes no sense in nominal terms; Padinha's version amounts to saying that prices are rising because prices are rising.
2. Does the year-on-year trend of real growth tell you anything I did not?
No, it doesn't. Since the year-on-year trend includes the high fourth-quarter-growth number, of course it will strengthen while that dog goes through the python. When the dog exits the python, the year-on-year trend will weaken again. Big deal.
3. Is the slowdown in real GDP "owing to acceleration in the price indices"?
That is not the way it works, James. Real GDP did what it did; you back out prices from the nominal measure in order to find out what real growth was. If the price index had gone up less, real GDP growth would not have been higher. Instead, nominal GDP growth would have been lower.
4. Is inflation incipient?
Padinha cites a
GDP price deflator rising at 1.8%. What was the average for this particular inflation rate over the long noninflationary period since 1984? Answer: 2.7%. As for the
CPI at 3% -- is this number high or low? It is a little higher than the average of this decade (about 2.9%) but not significantly so. Is this so high that we should give up a million or 2 million jobs to bring it down? Yours first, James.
5. Does "money growth fit ... into the inflation equation somewhere"?
No, actually, it does not. Those equations collapsed more than a decade ago, James. Didn't you notice?
But speaking of things that ought to fit into the inflation equation, don't forget that the
didn't just "tap the brakes" in April. It's been doing this for almost a year. At the time it started raising rates, the monthly inflation rates really were next to nothing. Isn't it at least possible that some of the rise in prices since mid-1999 is pass-through of rising interest costs? Sure it is.
6. What about "extreme worker scarcity"?
Yup, wages are rising a little bit more than they did in 1994, when the unemployment rate was still above 6%. Yup, firms are having to reach a little bit outside the "traditional labor supply" -- more jobs for women, for minorities, for older workers. More upgrading of the millions of bad jobs we've created since the 1970s, too -- lots of room for that. And those 4% wage increases -- the first real gains for low-wage workers in two decades -- are a good thing. May they continue, I say.
7. What really happened in 1994?
It is a very interesting story -- I devote a good part of a chapter to it in my book,
Created Unequal. But it is not the story Padinha tells, of a noble Fed averting a runaway inflation threat with timely and judicious action. There was no inflation and no threat of inflation at that moment. But there was a
, owing to the relative costs and prices facing banks. The actual effect of the Fed's decision to begin raising rates in February 1994 was to
bank commercial and industrial lending (which started rising almost immediately) by squeezing the margin on bank investments in government bonds. On this ground, it was a reasonable policy, though I criticized it at the time. It was, in fact, stimulative, and it may have prevented an even sharper slowdown than what occurred. But it had nothing whatsoever to do with fighting inflation.
8. And what about 1984?
Padinha asked me by email for a single case of our economy slowing down on its own, and I helped him with that example. The rest of his riff on 1984 he made up on his own. Yeah, it was a different part of the cycle. So what?
9. Should the Fed have done something else?
Sure. Let me say it again: Raise margin requirements. And how about
? Again, sure. Enact a transfer tax on stocks, credit it to the Social Security fund and cut the payroll tax on workers -- a measure that would reduce employment costs nicely, thank you very much. An increase in the capital gains tax, why not? Sorry to say it in this place, but people really should work for a living, most of the time. (Ah, the Protestant ethic, sorry, I can't help myself.)
9.5 again. Forgive me for leaving the wrong impression: I do not favor a purely passive policy.
What I oppose is a policy that will wreck, rather than sustain, full employment without inflation. As an expansion matures, care must be taken to keep bubbles from developing. Investors should be encouraged to diversify their asset holdings, not to concentrate them.
The policy we have, of fostering bubbles only to pop them, is silly. It's also dangerous, destructive and irresponsible, not only on the national but on the global scale. Of all the policy measures we have, moving the interest rate up and down may be the most convenient. It can be done in secret by a cabal. But it does not have magic effects on prices or the growth rate. It works only when interest rates go high enough for long enough that businesses start to fail in large numbers, people get laid off, and credit demand falls on that account.
That is why, on general principle, raising the interest rate is the policy instrument we should use the least.
That we use it first and foremost is evidence of weak minds, weak institutions and poor economics. And also of too much uncritical adulation of the very modest talent on and around the
Federal Reserve Board
James K. Galbraith believes in full employment, balanced growth, reasonable price stability, low interest rates and the great Ogden Nash couplet: "if there is one virtue to Americans unknown, it is: leave well enough, alone." He 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 at
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