302. "Beware of Rain Dancers at the Fed," The New York Times, Viepoint, (June 28, 1998), p. BU 13.
These are Goldilocks years for the economy, but hardly for economics. Two major tenets of economics have proven to be erroneous, only after causing considerable harm. These failings deserve attention not to put down the dismal science another peg or four, but because they still influence public policy makers. The first economists' tenet that has imploded is that if unemployment fell below six percent (according to some conservative economists, below 6.5 or 7 percent, the so called "natural rate"), the USA would face accelerating wage and hence price inflation. The second one is that if the economy grew at a real rate exceeding 2 1/2%, inflation would take off like a jet from an aircraft carrier. Economists have derided those who have argued that the economy could grow at a faster rate without endangering price stability as wooly-headed, soft-hearted liberals.
The slower-is-safer theorem had considerable consequences. During the 1980s the Fed again and again stepped on the monetary brakes whenever the economy picked up steam and employment approached the "danger" zone. Indeed, the Fed raised interest rates repeatedly, sometimes seven times in a row, until the economy buckled under, growth fell, and the jobless rate was successfully pumped up.
The costs the Fed are willing to incur to fight inflation are far from trivial. With every loss of one percent growth in the GDP, the nation would be short some $73.6 billion in goods and services, using the projected 1998 growth as a base for calculations. If one annualizes the last quarter figures, in which the growth rate was 1.7% above the one permitted in the past, the nation would gain a cool $125.1 billion of GDP. Such "extra" growth would yield additional tax revenue sufficient to pay for health insurance for all uninsured children, pay for badly needed school buildings and allow mothers of infants to stay on welfare. The same growth could do wonders for Social Security. The higher growth stretch we just experienced already pushed the date at which the system will turn red into the future by three years.
Often overlooked is the fact that for every year that economy is unnecessarily slowed, the GDP experiences shortfalls for years to come! One must recall that next year's economic base (from which percent of growth is calculated) reflects the result of the growth of this and previous years. Hence, if, for example, the economy grows at a rate higher by 1.5% every year for ten years, the GDP would be larger not by 15% but by 17%. Two percent may sound like small beer, but to reiterate, actually buys a hell of lot of whatever the nation desires. One may argue that sooner or later we shall face a recession. True enough, but it would be from a significantly higher top.
Keeping unemployment higher than it must be also has serious consequences. John Hopkins Professor M. Harvey Brenner found that recessions swell the rates of mental illnesses, suicide, murder, marital difficulties and family breakups.
Economists remind one of a study by E. E. Evans-Pritchard. The anthropologist wondered how rain makers could stay in business, given that they hardly produce rain on demand (or dance). The shamans, he found, had well honed rationalizations. When no rain drops followed their rituals, the rain makers would claim that the dance was not properly performed and had to be repeated (the way the Fed used to argue, after the fact, that it did not raise interest rates enough last time around). Rain makers would also maintain that some unexpected extraneous force intervened, black magic by enemies of the tribe most likely. Economists now suggest that global competition keeps wages down because workers are said to fear for their jobs and hence not ask for raises. M.I.T. economist Rudi Dornbusch came up with still another post hoc explanation: he stated that low inflation is due to the weakening of labor unions--just as the unions began to come back from a near-death experience. When all else fails, and there still is no rain in sight, shamans predict that the rain will fall--only later than expected. In the same vein, we are told, that inflation will rise--next year, which economists have been suggesting since 1994. In July 1997, economics professor Robert Gordon, who specializes in studying inflation, maintained that wage increases have been taking place but were "distinguished as promotions;" that their inflation effects will be felt soon "but it will take at least a year to see it happening." Other economists suggested that "...inflation may be already creeping through the economy on little cat's feet". Well, the year is almost up and so far the inflation-infested cat seems to have surprisingly small--and shrinking--feet.
Adhering to obsolescent economic theorems deserve special attention as the Fed is reported to be leaning again toward raising interest rates out of fear that the economy is growing "too fast" (although inflation is not simply low but the lowest it has been in 30 years). And, the American economy continues to be the envy of much of the world, as a fabulous job creating machine.
Given that the Fed has often erred on the side of excessive restraint, maybe the time is right to test the opposite limit: how loose it can be, without causing harm? Economists are quick to argue that inflation must be nipped in the bud, that once it takes off it is hard to reign in. But this is just another vague theory. There is no compelling evidence that if inflation were to double from its current level of 0.9% -- or even triple -- that this still-low level would unleash runaway inflation. This time there is ample room for experimentation, and yes, even taking some risk, on the growth side. After all, one notes, during the Kennedy Administration, the annual growth rate was 6% while inflation was kept under 1.3%. Given the current conditions the economy has little to fear -- save forlorn economic theories.
Amitai Etzioni is the author of The Moral Dimension: Toward A New Economics (The Free Press, 1988). He is the founder of the International Society for the Advanced of Socio-economics and University Professor at The George Washington University.