In doubling short-term interest rates over the past year, the Federal Reserve Board has emerged as the Washington Establishment's only hope for fighting inflation. Once again the wisdom of protecting its independence from political interference has been underscored. The Fed's high marks on monetary policy stand in sharp contrast to flunking grades on fiscal policy by elected politicians.
The Fed's decision yesterday to raise short-term interest rates by half a point to 6 percent -- double the level of a year ago -- may indeed slow the growth in gross domestic product from a torrid 4 percent in 1994 to 2.5 or 2.7 percent in 1995. But the lower number is precisely the rate considered necessary to bring the current boom in for a soft landing that will prolong prosperity and avoid sharp peaks and valleys in the business cycle.
The real gauge of inflation expectations lies in long-term rates -- the interest rates charged on 30-year mortgages or Treasury bonds. From the outset, Mr. Greenspan has said that long-term rates would drop once the financial markets are convinced that long-term inflation is under control. Well, the markets remain unconvinced. Long-term rates have gone up a couple of points in tandem with short-term rates.
Nevertheless, with 30-year Treasury rates sliding since November, there is a chance the turnaround toward lower long-term loans is close at hand. It may, however, require another increase in short-term rates to 6.5 or 6.75 percent.
In any event, the Fed's Open Market Committee does not reconvene until March 28. This will provide a long period for testing the markets and watching the economic indicators. Right now, the economy is still hot despite flat retail sales, auto production cuts, inventory increases and a fall-off in mortgage applications. GDP growth hit an unsustainable 4.5 percent in 1994's fourth quarter. Big ticket durable orders, factory utilization rates and construction schedules stand at 15-year highs. Skilled labor shortages are cropping up as the creation of 3.5 million jobs last year dropped unemployment rates from 6.7 to to 5.4 percent.
Bleatings from Capitol Hill that the Fed was wrecking the economy have been proven wrong again and again. Indeed, the very strength of the economy and the fine performance on inflation are good indicators that Fed policies are fairly on target -- that inaction by the nation's central bank would have sent inflationary pressures (which are still worrisome) spinning out of control. So, good for the Fed. May it hold to its course, especially as politicians get into a reckless race on tax cuts.