If Fed lowers rates, inflation may revive Greenspan and Co. playing with fire on the world stage


NOW that the wildfire on Alan Greenspan's left has diverted his gaze from the termites on his right, perhaps it's time to pay the termites a closer look.

Inflation could awaken.

No, that's not exactly the consensus opinion these days. Inflation's obit has been printed more often than Mark Twain's, and Greenspan's semaphore last week that he's ready to lower interest rates shows that even he may be starting to believe it.

"I've had to change my view on the Fed," said John Zaehringer, chief economist for Loomis, Sayles & Co. and a sturdy believer in Greenspan's inflation obsession. "It sure looks like they're setting up to ease." Greenspan's words last Wednesday, he added, "changed things a lot."

Greenspan is chairman of the Federal Reserve, which pilots short-term interest rates by altering the money supply. Money affects inflation; too much money chasing too few products makes prices go up.

The Fed has fixated on inflation for two decades like a cat on a goldfish. Fearing a return to the poisonous price spirals of the 1970s, the Fed kept money tight and rates high, hoping a stable dollar would anchor a robust economy. Only one thing has

broken the monomania: financial crises. When banks skirt the abyss, the Fed pulls them back with cheap, plentiful funds on the theory that inflation is terrible but insolvent banks are worse.

That's what seems to be happening now.

As the Asian economic conflagration has blotted up liquidity, the world cried out for dollars to support collapsing debt. Greenspan demurred for months.

But the latest betting is that he'll do what he did in 1987 and 1991: crank the spigot, flood the money markets and make dollars so cheap that even dumb lenders make a profit.

Maybe this week. Maybe even Japanese lenders, this time.

As he prepares to do so, it's worth remembering what happened the other two times.

Inflation stirred, stretched and sallied forth. It popped from 1.9 percent in 1986 to 5.4 percent in 1990, and it might have spiked again in the mid-1990s had the Fed not launched an early attack of higher rates in 1994.

It's unfashionable to expect a three-peat. Inflation has been 3 percent or less for seven years. Inflation is dead, the theory goes, wounded by productivity increases and workers timid to demand raises; done in by world recession and collapse of commodity prices.

Why, the producer price index is actually falling. Import prices are plunging. Treasury-bond yields imply that investors expect inflation of only 3 percent a year from now until 2028.

But some economists aren't ready to say last rites.

The deflating world economy is wed to physical goods, they point out. The U.S. economy, more than ever in history, is linked to brainpower. The 60 percent of the American economy fitting into the service category has only gossamer links to steel prices, commodities indexes, wheat yields. Fitness trainers in Omaha don't have to worry about competitors in South Korea.

And the deflation light isn't the one that's flashing on the service-economy dashboard.

Education inflation is above 5 percent. Drug prices are bubbling up. Lawyer and banking fees are rising. Rockville's BioReliance Corp. is giving unsolicited raises to most workers to keep them from jumping ship. Pay for management consultants, computer engineers, payroll administrators and other employees with business-service companies was 5.1 percent higher in August than a year previously.

"That's one number that hits you in the head when you're looking at these statistics," said Veronika White, an economist with First Union Corp. in Philadelphia. "I don't see how we can get into a deflationary environment in the United States if we can't bring service inflation below that magic 3 percent number."

Goods-based inflation is about zero these days, she said, while service inflation is scraping under 3 percent. The producer price index reflects only a minority, goods-tied portion of the economy. Import prices affect an even smaller portion.

If Greenspan mans the bilge pumps this week, remember that only a few weeks ago he said that the risks were "evenly balanced" between inflation and recession. Just because the balance has shifted doesn't mean that inflation isn't still a risk.

Pub Date: 9/27/98

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