White House Needs to Keep Hands Off the Fed

PRESSURE is building at both ends of Pennsylvania Avenue to force Federal Reserve chairman Alan Greenspan to cut interest rates and pump up the money supply. To his credit, Mr. Greenspan has politely ignored these catcalls from the peanut gallery. This was a brave decision. The Senate has yet to confirm his second four-year term as head of the central bank.The latest salvo came from White House chief economist Michael Boskin. He told the Joint Economic Committee of Congress last month that "the availability of credit in the United States is probably the single biggest threat to a sustained recovery." As he sees it, "the Fed is going to have to be prepared to add reserves to the system." (Reserves are raw material for the money supply.) Whether pumping up the money supply would also help President Bush's reelection campaign in 1992 is a separate matter that Mr. Boskin did not discuss. The rationale for easy money seems simple: Some measures of the money supply have grown very slowly in recent weeks. Should this pattern continue, so the story goes, the nascent economic recovery might end. As is often the case, economic reality and political perception are far apart. First, the high-powered money supply that actually influences future activity (bank reserves and transaction balances) is already going up at a rapid pace. Indeed, the surge has been too big to be sustained for a long period. The real challenge facing the Fed is not speeding up the money supply, but rather slowing it down. Second, the bounce in the US economy last spring was a lot stronger than the anemic four-tenths of 1 percent that the government reported. Domestic spending rose almost 3 percent at an annual rate in the second quarter. By the standards of prior recoveries, that was not a barn-burner. Nonetheless, it was a good start to a period of sustained growth. Moreover, the "weakness" in US foreign trade that held back overall gross national product performance was a statistical artifact. The US "terms of trade" (export prices divided by import prices) posted a big gain last spring. In the arcane algebra of economics, that made GNP look weaker. This distortion in the data will vanish when the Commerce Department shifts the base period for measuring US inflation to 1987 from 1982 this fall. Meanwhile, consumer income and spending are picking up, even as inflation is dropping. Such contrasting patterns, of course, have been typical of the early stages of most postwar economic recoveries. According to the Commerce Department, real personal income rose at an annual rate of almost 5 percent in June. This gain was the result of a super-solid advance in real wages and salaries, not a one-shot special event. At the same time, real consumer spending rose at a rate of more than 5 percent. However, the price indexes are flat. The best measure of the cost of things people actually buy (the "goods deflator") has gone up at a rate of only 1.5 percent during the past two years, with the exception of brief oil shocks in December 1989 and August 1990. A key element in White House planning for the 1992 Presidential campaign is a belief that interest rates (particularly home mortgage rates) will go down next year. Boskin predicted that steady reductions in inflation would lead to lower rates through 1996. That is a good forecast, but only if the White House has the sense to keep hands off the Fed. Without exception, nations with independent central banks have lower inflation rates and lower interest rates than countries where monetary policy is run by p oliticians. Last spring, German Chancellor Helmut Kohl appointed a hard-line monetarist, Helmut Schlesinger, to head the Bundesbank, Germany's central bank. Mr. Schlesinger is sure to give the Bonn government some sleepless nights. Nevertheless, Mr. Kohl did the right thing. Plainly, the Bundesbank will not acquiesce in the pickup in German inflation to 4.5 percent over the past year. "If there is a conflict between inflation and growth targets, which I do not believe there is in the long term," Schlesinger said recently, "then we will have to look at inflation." Good advice. Michael Boskin, take note.