Magazine article Mortgage Banking

Attaining Price Stability

Magazine article Mortgage Banking

Attaining Price Stability

Article excerpt

Could it be that the Fed believes that price stability has finally been achieved? If Chairman Greenspan's recent remarks to a group of Tokyo bankers are a reliable indicator, the Fed believes inflation has been licked for the near term and easy credit policy can commence to fuel the reviving economy in 1993.

When Federal Reserve Chairman Alan Greespan speaks, financial markets listen. His every word is dissected for possible nuances that may have escaped a casual observer. Suprisingly, one of the most intriguing of Greenspan's recent remarks has gone largely unheralded.

Speaking before a group of Tokyo bankers in mid-October 1992, Greenspan stated that "the true underlying rate of inflation in today's world may not be far from what I would call price stability."

For more than a decade, the Federal Reserve (Fed) has had as its top priority the achievement of an inflation-free economy. To reach that goal, the U.S. economy was put through the wringer of deep recession in the early 1980s, and the monetary screws were tightened again beginning in 1987, contributing to the slowdown in growth that began two years later.

While those efforts have succeeded in reducing inflation, they have not stopped the rise in prices altogether. Nonetheless, the Fed has made it clear that the achievement of price stability does not mean having literally zero inflation. "Price stability," to quote Greenspan, "is a condition in which households and businesses do not base their decisions on expectations of continued price inflation."

The importance of the Tokyo statement

Central bankers tend to be very cautious people, particularly when it comes to claiming victory over inflation. They know that, in the long run, inflation is a monetary phenomenon and that it could recur if they do not remain vigilant. Given that fact, Greenspan's Tokyo statement strikes me as profoundly significant. He is telling us, I believe, that price stability has now been achieved, for all practical purposes, so that the Federal Reserve's priorities can begin to shift away from a primary focus on bringing down inflation and toward encouraging a stronger pace of economic expansion.

If Greenspan's statement reflects a correct assessment of developments on the inflation front, it is extremely good news for the mortgage banking industry. An inflation-free economy means low interest rates, and that is quite obviously good for housing and mortgage banking. Moreover, a greater willingness by the Fed to accommodate economic growth would help foster the improvement in employment, consumer incomes and confidence needed to support a solid upswing in individuals' purchases of homes and other big-ticket items.

The evidence

A careful look at the evidence provides support for Greenspan's optimism. During 1993, inflation is more likely to go down in the United States than to go up. With price developments abroad also favorable, the basis is being laid for a prolonged period of tranquility on the wage and price front.

The great battle against inflation in the United States began in 1979, when prices were rising by more than 10 percent a year. Success in reducing inflation was not immediate, but during the deep recession of 1981-1982, the rate of price advance dropped very sharply. By the summer of 1982, however, the recession had become so severe that the Fed had no choice but to abandon temporarily its anti-inflationary stance to avert a collapse of the economy. And when economic growth turned up again, prices commenced rising at roughly 4 percent to 5 percent a year, and the inflation rate remained in that general range until recently.

Since the end of 1990, the inflation rate has dropped significantly further, to around 3 percent. As Figure 1 indicates, there were two earlier periods in the 1980s when inflation was temporarily lower than it is currently - at the depth of the 1982 recession - when price discounting was extremely heavy - and in 1986, when oil prices collapsed. …

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