May 24, 2000
RECKONINGS / By PAUL KRUGMAN
The Good News Bears
W hen I was around 8 years old, I had an occasional playmate who
was incapable of having a simple good time. If he was having fun,
he would overdo it, getting more and more wound up -- until,
inevitably, he would burst into tears and throw a tantrum.
Maybe he grew up to become a market analyst.
By rights, last week's half-point increase in interest rates should
have been a non-event. A rational financial market supposedly
reacts only to news -- and last week's move, which had been all but
pre-announced by Fed officials and which newsletters had been
predicting for a month, came as no surprise to anyone. And indeed
on the day of the increase, markets took it calmly. But then the
commentary began to take its toll: Inflation is back, we're headed
for a hard landing, there's a 50-50 chance of recession. To listen
to some of what's being said you would imagine either that Alan
Greenspan had suddenly revealed himself as a financial sadist or
that the mighty U.S. economy had suddenly been revealed to have
feet of clay.
So maybe it's time to re-establish some perspective.
The real news -- the background to the rate hike -- came not last
week but over the couple of months previous, as it gradually became
obvious that the U.S. economy had finally reached the limits of its
much-expanded ability to produce. Everybody who wasn't living in a
complete fantasy world knew this was going to happen eventually;
the amazing thing is that it took so long. And the signs that we
have reached our limits, though clear enough, are also fairly
subtle: a modest increase in inflation, mainly due to oil but with
some uptick in the "core" rate that supposedly excludes transitory
factors, an acceleration of wage increases to a rate a bit more
than productivity growth. Clearly it's time for the Fed to tap the
brakes, to reduce the growth of demand enough to bring it into line
with the growth in supply. But what now passes for a slowdown --
reducing growth to, say, 3 percent for a while until the
inflationary pressure eases -- would have looked like a boom only a
few years ago.
Could we be talking about something much worse than that sort of
benign slowdown? Bad things do happen when the Fed is in
inflation-fighting mode: the monetary contraction that began in
1979 eventually drove the unemployment rate into double digits. But
back then the Fed was dealing with an economy in which inflation
had been out of control for years, long enough that expectations of
continuing inflation were deeply embedded in the national psyche;
the Fed needed to take drastic measures in order to restore price
stability. Those drastic measures, and the bad times they caused,
wouldn't have happened if the Fed had moved quickly to control
inflation before it had time to get established -- if, in other
words, the Fed of the 70's had done what Mr. Greenspan is doing
now.
True, there are other dangers. Attempts to nip inflation in the bud
sometimes lead to the unpleasant discovery that your financial
system is weaker than you thought, with nasty consequences for the
real economy. That's what happened to Japan a decade ago, and it
still hasn't recovered (and won't, if Mr. Greenspan's counterpart
at the Bank of Japan -- who apparently is a financial sadist --
follows through on his plan to raise interest rates despite falling
prices). But recent events in the U.S. actually suggest that we
aren't as vulnerable as some, myself included, have feared. After
all, the Nasdaq -- which is where the irrationally exuberant
presumably put their money -- has fallen by more than a third, yet
stories of sudden bankruptcy, of failed investors jumping from
windows or shooting up brokers' offices, have been reassuringly
scarce. In a way the bad news -- or rather the financial system's
ability to take it in stride -- has been good news: I at least am
becoming steadily less worried about a Japanese-style implosion.
This does not abridge the right of investors to bear qualms. If you
think that stock prices in general are still too high -- a
defensible position, though not quite as compelling now that some
of the air has gone out of the tech bubble -- go ahead and sell.
But don't blame the Fed.
Copyright 2000 The New York Times Company