Newspaper article The Christian Science Monitor

Inflation Tip: Watch Money Supply

Newspaper article The Christian Science Monitor

Inflation Tip: Watch Money Supply

Article excerpt

These days, most analysts on Wall Street and the nation's monetary officials don't pay much attention to the growth in the nation's money supply. Yet the Federal Reserve's creation of new money remains vital to maintaining a vibrant economy without much inflation, at least in the long run.

The European Central Bank (ECB) and the Bank of Japan pay far more attention to money than the Fed does.

Right now, some economists reckon the Fed has been slightly too generous in pumping out new money in the past five years. If so, the inflation rate may rise modestly in coming months.

"A bit more tightening" is needed, says Bennett McCallum, an economist at Pittsburgh's Carnegie-Mellon University.

But the recent negative reaction of the stock market to what's seen as a new threat of inflation and thus higher interest rates is perhaps exaggerated. "We don't think the Fed is dramatically off course," Professor McCallum says.

His "we" refers to the Shadow Open Market Committee (SOMC), a small group of private economists founded in 1973 to evaluate the policy choices and actions of the Federal Open Market Committee (FOMC), the Fed's policymaking group.

Three decades ago, there was a vigorous debate between two schools of economics: the Keynesians, named after British economist John Maynard Keynes, and the monetarists, led by Nobel Prize-winner Milton Friedman.

The monetarists were winning the debate because their predictions, using a measure of money as a key forecasting tool, were proving more accurate than those of the Keynesians, who gave prime attention to variations in interest rates.

During the late 1960s and 1970s, Wall Street waited breathlessly every Thursday, after the stock market closed, on a Fed report on the growth of money.

"Today, no [financial] commentators talk about it," notes Henry Kaufman, a veteran Wall Street economist who was for a long time dubbed "Dr. Doom" because of his gloomy economic prognostications. (Many computerized models of the economy still incorporate money- supply figures into their formulations.)

Those with long memories will recall that in October 1979, a year when consumer prices rose 13.3 percent, the new Fed chairman, Paul Volcker, announced the Fed would henceforth control the money supply rather than interest rates in its anti-inflation policy. As the Fed slammed on the brakes, short-term rates zoomed up to 18 percent briefly.

The startling move - though not followed up fully in a monetarist, money-watching fashion - did burst the inflationary bubble. From a political standpoint, it was brilliant. The move gave other FOMC members and the White House cover for a stern monetary policy that resulted in a deep recession.

On the positive side, Mr. Volcker tamed inflation to the benefit of his successor in 1987, Alan Greenspan. …

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