Monetary Optimism
Jude Wanniski
August 29, 1988


Several discussions at the Fed last week on my trip to Washington suggest the following: domestic pressures on the Federal Reserve to further tighten monetary policy and slow the economy are being offset by international pressures to ease, to halt the dollar's rise in the foreign-exchange market. The half-point rise in the discount rate earlier this month has temporarily pacified the regional Fed presidents. Alan Greenspan, who at this juncture should be thought of as more of a diplomat than an economist, will resist further tightening moves to keep the split from deepening among the board of governors. He now has a non-partisan emblem to wear proudly, having tightened on the eve of the GOP convention. The stock-market crash also weighs on Greenspan's mind, Fm told, dampening his innate Phillips Curve fear of growth. I came away with guarded optimism, believing the Fed will resist the current manic cries for tighter money that are coming from the demand-siders, especially the monetarists.

The markets may still be worried about another Volcker-type deflation, the most recent of which lasted from the fall of '83 to the spring of '85. They shouldn't. This is a much healthier environment than in the fall of 1983, when all the pressures on the Fed were deflationary. Frank Morris of the Boston Fed, who then led the shut-down-the-economy forces, had only Preston Martin in opposition. Now, there are five growth advocates among the seven governors, and Morris is retiring. In 1983, there was no G-7 accord to attempt exchange-rate stabilization among central banks. Now, a further tightening by the Fed would force deflationary interest-rate hikes elsewhere. The most important differences, though, involve the dynamics of growth and price changes in the two periods. The growth track in late 1983 was steep and rising, catching the full effects of the Reagan tax cuts. The growth track now is nicely high, but no longer on a steep rise, hence not as scary to the Keynesians. Five years ago the price of gold, at $400, was telling us there would be a CPI inflation of 4 or 5% for several years to get to equilibrium. Now, at $430 gold, we're closer to equilibrium, and even with no further tightening gold will probably inch down toward $400 by year's end, suggesting CPI inflation in the next few years of 2, 3 or 4%. Greenspan now has a much easier job than Volcker did in 1983.

The clatter in the financial press predicting a series of discount rate hikes on the horizon reflects the demand-side views of Keynesians and monetarists. They couldn't understand how unemployment and inflation could rise simultaneously in the '70s and early '80s, and were baffled when they fall simultaneously. Monetarists, including the few on the FOMC, are shamelessly abandoning their money-supply models that signal no tightening. They're simply calling for a crunch to halt a "wage inflation" that can't occur unless there is first an injection of dollar liquidity sufficient to send gold shooting over $500.

The fact that Greenspan has been talking about "employment arbitrage" is extremely promising because the concept only exists in classical open-economy economic models, not the closed-economy models of the Keynesians or monetarists. The concept refutes the whole notion of wage inflation. The more Greenspan thinks about it and discusses it with the supply-siders at the Fed, the more comfortable he will be with economic growth rates that would terrify Frank Morris, or Paul Volcker.