Fed Raises Interest Rates Again – But Why?

08/25/1999 12:00am

Mark Weisbrot
San Diego Union Tribune, August 25, 1999

There they go again. For the second time in less than two months, the Fed has raised interest rates, despite the fact that inflation is running at 2.3%its third lowest reading in the past 34 years. What gives? How do they get away with it?

The most amazing thing is the lack of criticism, or even debate over a policy that has enormous costs and risks to the economy– not to mention the millions of Americans who will now find it more expensive to finance a car loan, or more difficult to find a job.

True, Fed chair Alan Greenspan is worshipped as a deity by the financial markets, and is probably the most powerful person in the country, after the President.

But the press is not necessarily afraid to challenge powerful people. Look at the torment they put President Clinton through, even after the public was nearly prostrate with scandal-fatigue. And since the media hounds decided that George W. Bush’s past drug use was an issue, it seems that all the would-be-king’s money and all his P.R. flacks can provide no refuge.

But Greenspan gets a free ride. Why? One key difference is that most Americans understand the concepts of sex and cocaine, but they don’t know much about the economy or the Fed.

So here’s a crash course before the Fed sends our economy over the cliff into its next recession: The Fed controls short-term interest rates– it can literally move them up or down and decides about every six weeks whether to do so. Because consumers and businesses borrow less when interest rates are higher, the Fed is therefore able to raise or lower the rate of growth of the economy.

And the same is true for unemployment, since fewer jobs are created when the economy is growing more slowly (or shrinking, in the case of a recession).

All that is not in dispute among economists. Here’s the controversial part: If We the People were in charge of the Fed, we would want the lowest unemployment (and the highest growth) that is compatible with keeping inflation under control. That’s because most of us have to work for a living, so we want more jobs, and the higher pay that comes with faster growth and lower unemployment.

But there is another constituency that speaks much louder into Mr. Greenspan’s big ears: the big bondholders. These folks lose big money when inflation picks up even a tiny bit. On the other hand, unemployment is actually their special friend, and they can score big capital gains when a recession hits. Readers of the business press will notice that the bond market generally rallies when the economy looks like it is going to falter, and tumbles when things are looking good.

Mr. Greenspan feels the bondholders’ pain when the good times are rolling along. So much that he even gets indigestion when wages start rising, since this (in his view, at least) can possibly lead to an upsurge in inflation somewhere up the road.

Call it callousness or indifference to the plight of working Americans– or call it paranoia. The choice depends on how much you believe that Mr. Greenspan really believes the stories he tells in his speeches and testimony.

Most of the business press accepts with wide-eyed innocence the Fed’s tired metaphor of inflation as a “genie” that, at all costs, must not be “let out of the bottle.” That credulousness, combined with Greenspan’s good fortune to have presided over the longest-running peacetime expansion in American history –so what if it has been driven by a stock market bubble?– seems to have put the Fed outside the reach of criticism.

Mr. Greenspan was itching to raise interest rates at about this time last year, but the instability of global financial markets forced him to move in the opposite direction. To his credit, he lowered interest rates by three-quarters of a point.

But what the Fed giveth under duress, the Fed taketh away– in spite of the fact that the lower interest rates did not cause any noticeable increase in inflation. So long as the Fed remains unaccountable to Congress and the public, we will continue to see unnecessary interest rate hikes. And perhaps– depending on where the Fed decides to stop this round of rate hikes– a premature end to the current economic expansion.

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