Ignore Soap Opera at the Fed: Watch Monetary Policy

Article excerpt

IN the last few weeks, the papers have been full of lurid tales of political intrigue in the Federal Reserve System. While much of this reportage was muddled and riddled with errors, the thrust seemed to be that a rebellious clique of hard-line inflation fighters had combined to frustrate Alan Greenspan's efforts to lower interest rates.

Even assuming that these Washington soap operas were completely true, they told us little or nothing about monetary policy or the process by which it is made. If anything, they obscured the basic issues: What are, or should be, the basic goals of monetary policy? What role should the White House and Congress play in overseeing their implementation?

The late Allan Sproul, president of the New York Federal Reserve Bank in the 1940s and 1950s, once observed that the Federal Reserve System was independent within the United States government but not of the government. This is a profound statement. It says that the Fed does not rank with the White House, Congress and the Supreme Court. Rather, the Fed is a political institution, which cannot operate for long outside the national consensus.

According to Benjamin Friedman, professor of economics at Harvard University, in practice the Fed's independence is always strictly limited. The notion that the central bank can pursue "an autarchic course, out of line with the remainder of the federal government, simply does not connect to the prevailing realities in the United States."

These basic questions are important at present because Mr. Greenspan has been doggedly pursuing the grail of zero inflation - a target neither the White House nor Congress has been willing to support. A resolution is pending in Congress to require the Fed to "adopt and pursue monetary policies leading to, and then maintaining zero inflation."

Even though this resolution has no chance of passage (its sponsor, Stephen Neal (D) of North Carolina) says he has 10 votes), Greenspan's actions have obviously been aimed at stable prices. Most economists would agree with Greenspan that "by ensuring stable prices," monetary policy can indeed create "a prerequisite for maximizing economic growth."

Where economists disagree, and disagree sharply, is over the short- and/or long-run costs of achieving zero inflation. Lee Hoskins, president of the Cleveland Fed, says flatly "there is no trade-off between inflation and recession. …