Townshend, Vt. -- THE FED'S reduction of one set of interest rates on Friday marked the beginning of the end of Alan Greenspan's war on inflation.
The war began in February 1994 with the Fed's quarter point increase in the rates that banks charge one another for overnight loans and led to a doubling of those rates, to 6 percent from 3 percent.
It is not quite over yet. The financial markets expect further cuts.
The war was phony. So was the enemy. Despite nonstop fretting by Mr. Greenspan, the Fed's chairman, no serious evidence of accelerating inflation ever emerged. For the first five months of 1995, consumer prices rose at a very modest 3.6 percent annual rate.
The economy is more fragile than the Fed had been willing to admit. For 18 months, we have been reassured that stable growth lay ahead. But now major indicators of growth like industrial production and the sales of cars and appliances -- all battered by needlessly high interest rates -- are down.
Yes, the economy may rebound from its multiple slowdowns. Sales of new homes -- not a generally reliable indicator -- looked good in May, but most other signs are bad.
On balance, the risk of recession is rising. The Fed's action shows that even its chairman has lost confidence in his earlier optimism.
The war against inflation was fought against an enemy that existed only in the imaginations and perhaps in the economic models of Mr. Greenspan and his colleagues. Yet there were casualties, as in all wars.
The middle class was hit hardest by rising adjustable-rate mortgages and the falling values of stock portfolios and pension funds most of last year, because when interest rates soar stock prices tend to fall.
The five-year federal deficit rose by some $200 billion in prospective interest costs, reversing much of the 1993 reduction. President Clinton's credibility has been damaged, for he had promised falling deficits and lower interest rates.
The Fed should have done nothing last year. Stable and low short-term rates would have generated stronger growth, lower long-term rates, higher investment and lower deficits -- without bringing on inflation.
If the Fed's campaign was based on a potpourri of prejudices, hunches and assumptions, an excessive fear of rising inflation and an insufficient fear of rising unemployment, then the operating methods and the biases of the decision-makers must be questioned.
The Fed's analytic methods are dubious. It has underrated fundamental changes in the economy, and it still places too much weight on the hoary assumption that inflation will rise if unemployment falls below 6 percent. It is currently 5.6 percent.
The Fed's economists apparently failed to predict that wages would stand still.
Since wages are always the largest element of costs, stagnating wages mean fairly stable, not inflating, prices.
There has been no increase in average wages despite falling unemployment, which reflects an increased demand for labor.
Why this stagnation? One big reason is the decline of unions. Another is intense competition from imports from low-wage countries.
When Mr. Greenspan next appears before Congress, he should be pressed for a full accounting of the forecasts and the theories underlying the needless war.
Congress should request the full records of Fed meetings and supporting analyses so that it and outside experts can try to understand what went wrong.
And when Mr. Clinton nominates his next candidate for the Fed's board, he and Congress should insist on a new spirit of openness in Fed deliberations.
James K. Galbraith teaches economics at the University of Texas at Austin.