US trading partners out to damp inflation - but US balks

The world economy is hot - perhaps too hot. That could mean rising inflation in the United States, Britain, France, Canada, West Germany, Japan, and other nations.

To halt the uptrend, central bankers around the world have been raising interest rates. The West German Bundesbank yesterday announced an increase in its Lombard rate. The bank's chief, Karl Otto P"ohl, described the German economy as being in a ``boom'' and said tighter monetary policy is appropriate.

France, Belgium, Britain, and the Netherlands have raised their rates in recent days also. But there's been one central bank conspicuous for its absence in this round robin of interest increases: the Federal Reserve.

Concern about aggravating the federal budget deficit and hurting United States trade competitiveness is the main reason the Fed is dragging its feet.

It's a curious position for the Fed to be in. Instead of leading the fight against inflation, as it did in the early 1980s, the Fed is playing cautious. In large part, its freedom to maneuver is restricted by concern about the dollar, the economy, government debt.

``It's not that the Fed's willing to tolerate inflation,'' observes Douglas McAllister, a government bond specialist with Prudential-Bache Securities in New York. ``It's that other countries are willing to move faster than our Fed. The Fed doesn't like knee-jerk actions; the Europeans are more willing to change things.''

Consider Fed chairman Alan Greenspan's dilemma. If he and his colleagues decide to push interest rates higher (indirectly, through the sale of securities; directly, by charging banks more for loans), the economy will slow down. That would cool off inflation and decrease domestic demand for imports.

But higher interest rates could make the dollar stronger in world money markets, which could make US exports less competitive abroad. A slow economy could cause tax revenues to decrease, worsening the budget deficit. And if rates go too high, the economy could stall, the US could slip into a recession, and the budget deficit could deepen dramatically.

If Mr. Greenspan does nothing, however, inflation will probably climb. Already, the economy is running at its lowest unemployment level in 14 years, retail sales are robust, and factories are at their highest operating capacity in nine years. These are signs of strength - but they also indicate potentially more inflation. The competition for workers could drive up wages; strong sales and all-out industrial production could boost prices for goods and services.

Too much inflation could cause a crisis of confidence in the economy. The dollar could plunge. Financial markets could be disrupted.

So, on balance, many economists think the Fed has quietly opted for gradually higher interest rates. A big move, such as an increase in the discount rate (the rate the Fed charges banks for money), probably won't come until next month. But financial markets around the world are expecting that it will come, says Mr. McAllister of Prudential-Bache.

Perhaps it will, says economist Sam Nakagama, with Nakagama & Wallace in New York. But there's no reason to be hasty. Other nations, he says, are raising their interest rates for their own special reasons: Britain and France to try to adjust balance-of-payments deficits; Germany, because of the German phobia about inflation.

``It is not at all obvious that the world is in the grips of inflation,'' Mr. Nakagama says. ``After all, we are living in one of the best of all economic periods - with low inflation, prosperity throughout the industrial nations. Why kick the US economy at this point?''

Also, he says, ``If the Fed tightens and the economy goes into a downturn, everybody will be screaming.''

Still, the US budget and trade deficits remain. Although iconoclastic economists such as Milton Friedman and Paul Craig Roberts contend that concern about these deficits is overblown, the concern persists.

``We have a massive trade deficit and the picture is not improving,'' says Lacy Hunt, an economist at Carroll McEntee & McGinley. ``We need to dampen domestic demand to moderate import growth.''

Dr. Hunt thinks interest-rate increases are overdue and says they are needed to curb the voracious appetites of American consumers. And he doesn't think higher interest rates will cause the dollar to rise significantly. Since other other nations have been raising their interest rates already, US rates will go up relative to them. That will keep the dollar about where it is.

Unlike Nakagama, Hunt wonders about the wisdom of the Fed's delaying.

``We have above-trend economic growth globally,'' Hunt says. This is causing above-trend inflation, and ``the foreign banks are more aggressive about raising interest rates to fight it.''