Fed's Roos warns: beware the 'easy' solution
Boston — The "worse thing" United States economic policymakers could do now regarding inflation is panic and attempt easy solutions through controls or other measures.
That's the view of Lawrence K. Roos, president of the Federal Reserve Bank of St. Louis.
In a telephone interview he noted: "It is important that the American people realize that the predicament we now find ourselves in is a result of 15 years of monetary and fiscal overindulgence. You don't cure this overnight."
That doesn't mean that Mr. Roos believes inflation is incurable. He is convinced that the central banks' new technique for better controlling the growth of the nation's money supply that was announced Oct. 6 will start to reduce the "basic inflation rate" toward the end of this year. There is a lag of 12 to 18 months, he explains, between the implementation of a tighter monetary policy and its actual impact on inflation.
Right now, he calculates, the "basic inflation rate" as measured by the broadest measure, the so-called gross national product "deflator," is about 7 percent. He expects the "temporary rate of inflation" that has to be added to that basic rate to run about 3 percent this year. The basic inflation rate is the result of the rate of supply of money to the economy in the past three to five years. The temporary rate is that part of inflation caused by short-run factors such as a poor farm crop or a large boost in oil prices.
Mr. Roos also suspects that the temporary rate of inflation also will be coming down as the year progresses. In other words, the giant jump in the consumer price index last month to an 18.2 percent compounded annual rate is not permanent. He sees the possibility of a smaller boost in petroleum prices this year than last. Further, he expects that mortgage interest rates -- one sizable factor in January's consumer price rise -- will decline later this year. That, he acknowledges, will require convincing the financial markets that the Fed is serious about its anti-inflationary stance.
Mr. Roos becomes a voting member of the Federal Open Market Committee (FOMC) in March, the powerful 12-person body that sets the nation's monetary policy. Although all presidents of the regional federal reserve banks can sit through FOMC meetings and join the discussions, only fire presidents can join the seven Fed governors in voting. The president of the Federal Reserve Bank of New York always has a vote. The other four votes rotate yearly among the other regional bank presidents.
From his observations of the FOMC meetings since the so-called "Saturday Night Special" of Oct. 6, Mr. Roos says he is convinced the Fed will stick to its announced targets for monetary policy and procedures.
"If the Fed were to retreat from the procedures and goals announced in October, this would destroy the last threads of credibility of the Fed in the world," he says. He feels the Fed has no other choice.
The Fed indicated last fall that in determining monetary policy it would pay less attention to interest rates and more to the monetary aggregates, especially total bank reserves.
Mr. Roos would like the Fed to take one more step. He would like it to announce in advance its targets for growth in total bank reserves and for the so-called "monetary base" -- a combination of reserves and currency in circulation. The Fed already states its goals for various monetary aggregates -- the various measures of money supply, or "M's."
"The best way to gain confidence," he says, "is to spell out our game plan quite specificially. It has the risks that if we stray from the path, it might cause some confusion in the financial markets."
But he believes any such confusion would certainly be no worse than that the markets often now experience. As one example, he cited the sharp drop in long- term bond prices last week when the Fed hiked its "discount rate" -- the interest rate it charges on loans to commercial banks -- by 1 percent to a record high of 13 percent.
Since this move reflected the determination of the Fed to reduce inflation, economic logic should have dictated steady or even higher long-term bond prices, he argues. But the market evidently didn't believe the Fed's anti-inflation intentions.
Mr. Roos does not want a dramatic reduction in the supply of money to the economy -- the supply of the lubricant that keeps the nation's economic machinery running. That could cause a deep recession. He would like to see a steady reduction in the growth of money -- say by 1 percent a year. He believes Mr. volcker has a similar plan. This would trim the inflation rate gradually without a sharp recession. Such a plan could reduce the basic inflation rate to zero by the second half of the decade, he maintains.
But, he warns, if this election period produces panic among the politicians, it could set back significantly such long-term anti-inflation efforts.