WILL the Federal Reserve Board shoot down the fledgling recovery?
Recovery from the 1989-1991 recession technically began nearly three years ago, when economic growth resumed in the spring of 1991. But until lately, the recovery was notable mainly for its weakness.
According to every indicator -- the growth of jobs, investment, corporate earnings and the overall rate of economic growth, this had been the most feeble of any recovery since World War II.
Finally -- belatedly -- the economy shows signs of life. Holiday retail sales are rebounding. Industrial production is surging. Economic growth in the final quarter of 1993 is expected to be around 4 percent. And the economy is finally beginning to generate jobs.
Why did this economy take so long to catch fire? During the 1980s, we went on a borrowing binge. We built too many of the wrong things and we paid too much to build them. The early 1990s were a morning-after. It has taken the economy time -- to absorb the junk bond debt and the overbuilt office buildings, to heal the damaged banks, to restructure industry and get rid of overcapacity.
This recovery was also slow because wages have been flat and jobs precarious. Wage earners with stagnant earnings and fears of pink slips do not spend freely.
President Clinton bet that low interest rates would eventually get the economy moving again. After an agonizing delay, Mr. Clinton seems to have been proven right. It took awhile, but lower interest rates have finally improved the balance sheets of banks, businesses and households. As commercial loans, mortgages and consumer debts have gradually been refinanced at lower rates, people and businesses have more money to spend and invest.
But although the recovery is just taking off, interest rates are already up half a point from their spring 1993 low. To some extent the uptick in rates is the market speaking. As the demand for credit rises, its price goes up. However, the rise in interest rates also reflects deliberate Fed policy. Summaries of meetings of the policy-setting Federal Open Market Committee (FOMC) suggest that throughout 1993 the FOMC usually voted to tighten money at the slightest sign of inflation.
In fact inflationary pressure is non-existent. The prices of raw materials have been declining. Oil, which was selling for about $20 a barrel at the beginning of 1993, is now at about $15 and headed lower.
Wage inflation is also absent, because of weakened trade unions, heightened foreign competition and continued corporate downsizings. In November, the Consumer Price Index rose just two-tenths of 1 percent.
Yet the Federal Reserve Board is still inflation-phobic. The Fed fears that if strong growth continues, there will be excessive demand for credit and upward pressure on wages. Hence, the Fed reasons, we need to nip inflation in the bud before it gets started. Better recession than inflation.
This view is absolutely perverse. Raising interest rates prematurely is the surest way to kill a recovery. Higher rates would also torpedo the stock market.
The economy is already paying a heavy price for the Fed's inflation-phobia. Long-term interest rates have come down steadily since the late 1980s, but in "real" terms (adjusted for inflation), they are still at least a full point above historic norms of 2 1/2 percent.
Until now, the Clinton administration has had a nice honeymoon with the Federal Reserve. But that may soon end.
The administration sensibly wants to consolidate banking regulation in a single new agency. The Federal Reserve, which would lose its partial responsibility for bank supervision, opposes this loss of turf. The Fed also opposes the administration's proposal to toughen the Community Reinvestment Act, requiring banks to invest in economically depressed communities.
In January, President Clinton makes his first appointment to the Fed's Board of Governors to replace Wayne Angell, whose term expires. Mr. Angell has been one of the Fed's real tightwads. Though it would annoy Fed Chairman Alan Greenspan, Mr. Clinton would be wise to appoint someone firmly committed to keeping interest rates low over the long term.
Whenever the White House or the Congress complains about the Fed's addiction to tight money and slow growth, it is conventional to warn that the Fed should be above politics. But whether the Fed serves mainly the interests of creditors or the broad public is a deeply political question. If the Fed wishes to keep its cherished independence, it should nurture the recovery.
Robert Kuttner writes a column on economic matters.