The Fed's Official Bird? Right Now, It's the Hawk

Bucking convention, Fed officials are starting to take their dissenting policy opinions public.
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It's not hard to tell who's in charge around the offices of the

Federal Reserve

these days.

It ain't the doves.

Events since the Fed last hiked rates on Nov. 16 -- the third hike of the year -- show that of the various factions on the

Federal Open Market Committee

, those worried about wage inflation getting out of control are making their presence most strongly felt. Curious, because it hasn't happened yet.

Most of the market expected the last hike, but didn't expect the hawkish-sounding

warning about further inflation due to a shrinking pool of workers.

Dallas Fed President

Robert McTeer

, the Fed official who most openly embraces the "New Era" economy (productivity enhancement will continue to offset labor costs), made his disappointment known in a Nov. 18 editorial in

The Wall Street Journal

and in subsequent speeches. Fed officials rarely express public disapproval with the committee's decision, even if they don't agree.

Fed Governor

Laurence Meyer

, generally regarded as one of the Fed's deepest thinkers, if not also the most hawkish,

explained in great detail his concerns about the economy on Nov. 30. The hawkish speech immediately rattled the market and continues to do so a week later.

Now, the opinions of Fed officials, left and right, generally tend to fall toward the giant magnet that is Chairman

Alan Greenspan's

centrist viewpoint. But if recent weeks are any evidence, the Fed is leaning to Meyer's side.

McTeer Goes Public

In its Nov. 16 statement, the Fed warned that the shrinking workforce is a trend "that must eventually be contained if inflationary imbalances are to remain in check and economic expansion continues." It was a more alarmist statement than the markets expected. The wording was almost identical to sentiments expressed by Greenspan in an Oct. 28

speech in Florida.

Two days later, McTeer's editorial, "Believe Your Eyes, the New Economy Is Real," showed up. He explained his dissenting votes from the Fed's decision to hike rates in both June and August. He added that the Fed's earlier "policy forbearance" in not raising rates as productivity improved was a "calculated risk, but it was ultimately rewarded with 4% real growth, 4.2% unemployment and core inflation below 2% -- all better levels than most models had predicted."

McTeer was more candid in a speech in London that week. Terming the Fed's more tolerant policy toward productivity improvements a "courageous experiment," he said, "I thought the experiment could go on awhile longer without significant risk, but my colleagues didn't wish to push their luck." This implies he dissented again in November.

"It's unusual behavior," says Russ Sheldon, chief economist at

MCM Moneywatch

. "He's suggesting now that he feels his position is not going to win the day. If it had been a close call, he'd play by the rules, but when he sees that tightening might go further he went public with it."

The inherent problem with McTeer's view is that it ignores favorable supply-side shocks such as plummeting commodity prices, the incredible strength in the dollar and the easy availability of credit -- all consequences of the Asian/Russian economic crisis, which caused the Fed to cut rates three times in 1998 when it was earlier contemplating raising rates.

In a sense, McTeer's experiment was forced on the Fed. (The Fed did leave the funds rate steady between March 1997 and September 1998, as Greenspan recognized technology improvements might garner the Fed a little leeway.)

"Greenspan was sympathetic to this argument going back to at least the July 1997


comments," says David Jones, chief economist at

Aubrey G. Lanston

. But "Greenspan is increasingly concerned that the declining pool of available workers will cause compensation to grow faster than the improved productivity figures last year, and that's a prescription for increased inflation."

Meyer's First Name Is N-A-I-R-U

That's precisely Meyer's worry. What made people take notice of Meyer's speech were the round numbers he attached to it. He put his


figure -- the nonaccelerating inflation rate of unemployment -- at 5% to 5.25%. That means he expects wage inflation would pick up once the unemployment rate falls significantly below that figure, bar none. But he admits that he would be willing to let the productivity experiment continue if the unemployment rate still hovered around 5%.

To him, 4.1% is too low. "In my judgment, we are already in a range in which such a normal response to further declines in the unemployment rate is warranted," he warned in that speech.

Mickey Levy, chief economist at

Bank of America

, pokes a hole in this theory by pointing out that Meyer's previous NAIRU estimates around 6% or 6.5% were wrong. Wage inflation still hasn't emerged despite Meyer calling attention to the figure for several years.

What supports Meyer's theory is that hourly wages aren't rising because employers are finding ways to defer salary through bonuses, incentives and stock options -- all contributing to an asset bubble. Last week's

unemployment report

doesn't show a slackening in overall labor conditions. If the market's reaction is any indication, it's minding Meyer over McTeer right now.

Levy points out that Greenspan's ever-evolving view is still most important. "He has more patience" than anyone else, Levy says, and Greenspan's constant reevaluation of economic conditions makes it difficult to tell where the Fed will go because he finds multiple hypotheses credible.

But if McTeer's experiment is over, Meyer's might just be beginning.