Inflationary Flap

`BUNDESBANK surprises the world.'' ``Nasty shock.'' Those were a couple of the newspaper headlines last week after the West German central bank raised interest rates in an attempt to squelch inflation.

Given the interdependence of world financial markets, the news prompted reactions around the globe. Stock and bond prices fell almost universally. So did the United States dollar on the foreign-exchange market. The price of gold rose modestly. A few European nations in what is called the ``mark bloc'' - the Netherlands, Austria, Belgium, and Denmark - raised their own central bank interest rates.

Even the White House got into the act. A senior administration official was quoted as saying, ``It's unlikely the Fed will respond. No one's awfully worried - yet.''

It was quite a financial flap.

No one is too worried, because chairman Alan Greenspan and his policymaking colleagues at the Federal Reserve System have proved themselves rather unflappable. They don't panic easily. That was evident when the stock market collapsed in October 1987. Mr. Greenspan made a short reassuring statement to the investing public and briefly pumped up the supply of money until fears had receded.

Another reason the Fed probably won't react - and shouldn't - is that the monetary situations in the US and Germany are entirely different.

In Germany, the money supply has been expanding considerably faster than the Bundesbank's target. In the US, the narrow definition of the money supply (known as M-1) has been shrinking the past three months (minus 0.7 percent annual rate); the broader category (M-2), which includes some savings, has been growing at a modest 1.9 percent annual rate, well below the Fed's target.

Since money (currency plus bank checking accounts) is the fuel for the economy, the Fed has already put the squeeze on business activity in its battle against inflation. The economy is already slowing. The big question is whether the Fed has applied so much restraint that the US will soon suffer a recession.

In Germany, the economy has been rushing ahead faster than expected, helped by strong exports. And German manufacturers are already using a high 90 percent of their capacity. A weaker dollar should trim Germany's too-high trade surplus and encourage US exports. Topping it all, inflation shows signs of moving up to a 3 percent rate in Germany - too high for that inflation-averse nation.

The Bundesbank acted in the self-interest of Germany. Fortunately, this action could also ease imbalances in the world economy.

About these ads
Sponsored Content by LockerDome

We want to hear, did we miss an angle we should have covered? Should we come back to this topic? Or just give us a rating for this story. We want to hear from you.

Loading...

Loading...

Loading...

Save for later

Save
Cancel

Saved ( of items)

This item has been saved to read later from any device.
Access saved items through your user name at the top of the page.

View Saved Items

OK

Failed to save

You reached the limit of 20 saved items.
Please visit following link to manage you saved items.

View Saved Items

OK

Failed to save

You have already saved this item.

View Saved Items

OK