Growth without pain Dogma: A "natural" jobless rate of 6 percent to avoid inflation is being questioned even by economists.

THE BALTIMORE SUN

The June sun is already scalding the damp sidewalk that leads to the unemployment office on Eutaw Street, and already the jobless fill out forms in the cramped plastic seats inside.

It's 10: 15 a.m. on a Friday. Each applicant's tale is as particular as his Social Security number. His plant closed for the summer. Her restaurant went out of business.

But the scene is timeless, built into the government, programmed into economists' equations.

In Maryland alone, unemployment employs more than 600 people, perpetually, to process benefits applications, issue checks and such. Economists speak of a "natural" rate of joblessness of about 6 percent. When the number of adult Americans who want to work but can't is about 7 million, prevailing economic theory implies, all is right with the world.

But the prevailing theory is under siege. Nobody is saying unemployment can be abolished, but long-held ideas about how fast the economy can grow and how low the jobless rate should sink are being challenged as they have not been in years.

Specifically, critics of the Federal Reserve say that the nation's central bank has been too strict, that it can lower interest rates to stimulate the economy and reduce unemployment without making inflation worse.

That notion, in most economic circles, is heresy.

Accepted wisdom holds that whenever more than 94 percent of the work force holds a job, the resulting labor scarcity forces companies to boost wages. Higher wages get passed along as higher prices for goods and services, and inflation bites deeper into money's value.

The 94 percent rule, contends Paul S. Sarbanes, Democratic senator from Maryland, is "dogma that really doesn't work. We need some fresh and broader thinking. I think we can have faster growth and not have an inflation problem."

The liberal Sarbanes has been saying such things for a long time. But the ideas are gaining a wider hearing, thanks to the economy's continued torpor, presidential campaign debate, recent congressional hearings on Fed appointments and a growing suspicion that the global marketplace truly has nullified the 94 percent rule.

"You have had a series of structural changes in the last decade that have basically increased the potential of the economy to grow without inflation," said Jerry Jasinowski, president of the National Association of Manufacturers, a Washington trade group. He wants the Fed, whose rate-setters meet this week, to cut short-term interest rates by a quarter percent this year and another quarter percent later.

Jasinowski warns that rates should be cut cautiously and that faster growth also requires tax reform, better education and other remedies. But he's an important poster boy for the forces for lower rates: He represents big business, which is nothing if not economically conservative. And he is trained as an economist, the profession that has sanctified the 94 percent rule.

But business people aren't the only ones lured by the concept of pain-free economic stimulation. Amid flat personal incomes, shrinking corporations and one of the slowest economic recoveries on record, the idea promises payoffs for workers and policy-makers as well.

"We can't solve any of our basic economic and social problems and balance the budget and make the investments we have to make without higher growth," said Felix G. Rohatyn, a managing director of investment bank Lazard Freres & Co. and another in a minority of big-business inflation "doves." "We shouldn't be afraid of growth."

Even small changes in economic growth rates make huge differences in Americans' lives. The Fed's perceived "speed limit" for the gross domestic product now is 2.5 percent annual growth, about its current rate. Any faster, policymakers fear, and unemployment drops and inflation rises.

Suppose, though, that the Fed's critics are right, that the economy could grow steadily by, say, 3.5 percent annually. It's ,, not out of the question. Between 1945 and 1988, the economy grew at an average yearly pace of well over 3 percent. Since then, growth has been more like 2 percent.

"It makes a whopping difference," said Gary Robbins, a research fellow with the Institute for Policy Innovation. A percentage-point increase in GDP growth now could wipe out the federal budget deficit in five years, he said. It would cut the long-run Social

Security deficit by half.

"That's why people should be concerned," Robbins said. "It's the difference between whether some people are going to get their benefits or not."

Growth advocates claim that the Fed is fighting the last war, that policy-makers and Wall Street learned the lessons of the 1970s a little too well. Thanks to oil shocks, stronger unions, a hesitant Fed and a consumer psychology that accepted higher prices, inflation hit double-digits four times between 1974 and 1981.

To retaliate, the Fed did what central banks always do when money's integrity is threatened: It cut the money supply, raised rates and choked the economy. The result was the worst economic slump since the Depression.

Since then, Wall Street and the Fed have been hyper-vigilant. In 1994, for example, the Fed surprised almost everybody by cranking up rates while the recovery was still a toddler, and a sickly one at that. The funds rate, the Fed's main lever on the money supply, went from 3 percent to 6 percent. It has been 5.25 percent since February.

The Fed should relax some more, people like Rohatyn argue. The demons that drove inflation berserk 20 years ago are gone, and a powerful straitjacket has taken their place.

Oil prices have been tame, for one thing. Inflation-adjusted oil prices are lower than they were in the early 1970s. But the strongest restraint on prices is the globalized economy. Now that corporate chieftains hire and sell across borders, and buying consumers can do the same, price competition is literally everywhere.

The cycle reinforces itself. Workers fearful of losing jobs to overseas competitors accept flat wages. Because of those flat wages, the workers refuse to accept price increases in the things they buy. Price increases, in turn, are something that companies can avoid -- because wages are flat.

The proof is in the latest economic figures, Fed critics say. U.S. employment has been above the critical 94 percent level since 1994. Unemployment now is only 5.6 percent. But not counting the volatile food and energy sectors, consumer prices have been rising at their usual, sedate annual rate of 3 percent so far this year.

Perhaps unemployment should fall to 5 percent, or 4.5, some argue. That's an extra million people who would be working. At least the Fed should experiment with lower targets, they say.

Many economists also argue that inflation is even lower than we think it is. The Consumer Price Index supposedly rose 2.5 percent last year, but even Fed Chairman Alan Greenspan has told Congress that true inflation could be 1.5 percentage points lower than the CPI. The index doesn't account for the trend toward discount shopping; it doesn't measure service prices very well and it misses product-quality improvements, its critics say.

"There are no ghosts in the attic," MIT economist Lester Thurow writes in his book, "The Future of Capitalism." "Inflation is not about to rise from the dead." Thurow thinks the government could be overmeasuring inflation as much as 3 percentage points.

Like another economic heresy broached this year -- Pat Buchanan's contention that free trade is bad and higher tariffs can protect U.S. jobs -- the idea that the Fed can relax and unemployment can shrink gets stony rebuttal from most economists.

And even analysts like Bill Cheney, the chief economist for John Hancock Financial Services in Boston who says he "has a lot of sympathy" for the view that the Fed is too restrictive, are wary of recommending such a course.

"Any good model of the economy contains enough time lags" to explain why unemployment below 6 percent hasn't kicked up inflation yet, he said. "It's always a weak link to say the world has changed and the old rules don't apply. Sometimes it does change. But the majority of times, when people say it has changed and they identify a new trend, it turns out they were wrong."

The economy's real problem, many analysts argue, is not a tight Fed but a slow-growing labor force and slow productivity improvement. If the work force isn't growing very fast, and if companies aren't managing to produce many more goods and services with the workers that they already have, then by definition the economy can't grow faster than it is.

"The growth rate looks low, but it looks low to an important extent because the labor force is growing so slowly" -- much more slowly than from 1945 to 1985, said Paul Boltz, chief economist for T. Rowe Price Associates Inc.

In this view, economic stimulus by the Fed would be pushing up a rope. Sure, the Fed could loosen, monetary conservatives argue. But because companies couldn't use the money spurt for new hires or to increase productivity much, it would have no place to go but into inflation.

There's another danger. If the bond market thinks the Fed is about to allow an inflation spike, it will raise long-term interest rates to compensate for the expected erosion of money's value. Higher long-term rates are exactly what the economy does not need; they would quash hiring and investment and cause a recession just as fast as any money-supply decrease engineered by the Fed.

But if anybody can convince bond investors that inflation indeed is vanquished and that the Fed could loosen without risk, Greenspan is the man, says the fast-growth faction, hopefully. Only somebody with such blue-chip, inflation-hawk credentials could credibly reverse course, they say. It's the "Nixon-going-to-China" scenario.

"Expectations in this game are so important," said Charles McMillion, president of MBG Information Services, a Washington economics consultancy. McMillion is concerned about Wall Street's reaction to a softer Fed. But if somehow the Fed could ease without spooking bond investors, he said, "it would be very good for consumers, very good for business and the global economy."

Greenspan shows no signs of being converted. And even the Clinton administration has, for the most part, supported his tight-money policies. But people like Sarbanes hope that, when the Fed's rate-setters meet behind closed doors this week, some of the arguments for faster growth will have slipped inside.

Pub Date: 6/30/96

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