There is a point–and we are not far from it–at which America will flat run out of people who want jobs, even though the economy will still be creating new ones. That’s what Federal Reserve Board Chairman Alan Greenspan means when he keeps talking about “unsustainable” growth. Something has to give.
The give in that scenario is higher wages–higher even than the recent robust gains in productivity warrant. That’s the road to higher inflation, leading to even higher wages, leading to yet more inflation–in a vicious circle that is the toxic opposite of the virtuous circle the American economy is currently enjoying. Greenspan’s Fed is determined we are not going to go barreling down that road and, to make sure of it, is placing speed bumps to slow us down.
The latest such bump was Tuesday’s one quarter of 1 percent increase in the short-term interest rates the Fed controls, raising the federal funds target rate on overnight borrowing among banks to 5.5 percent and the discount rate at which it lends money to banks to 5 percent.
These higher rates are already rippling through the economy, as banks raise their own lending rates governing everything from mortgages to car loans to interest rates on credit cards.
This marks the third increase in short-term rates since June and returns them to where they were 14 months ago before the Asian financial crisis that reverberated around the world prompted three successive emergency cuts in the fall of 1998.
Financial markets reacted positively to this latest increase because it came with a sweetener–a signal that the Fed was unlikely to do anything else for awhile. In opaque Fed-speak, the outlook for policy is now “symmetrical.” Consider the policy car in neutral for the time being.
This isn’t surprising given the uncertainty that will prevail over the next several months as the 20th Century ends and the 21st is born. The potential for glitches at Y2K is leading businesses and consumers alike to distort their normal spending and investing habits, which will make for a muddle statistically for awhile.
That explains the timing of the Fed’s action. Economists can differ about the need for this move–given today’s benign inflation picture–but it is difficult to quarrel with the Fed’s desire to keep this remarkable virtuous circle intact. It has brought unprecedented prosperity to Americans, and continued low inflation is the crucial ingredient.
