Keep Money Growth Stable as Economy Rebounds

INFLATION is winding down. The staff of the International Monetary Fund estimates that consumer prices in the major industrial nations will rise 3.8 percent next year, down from 4.5 percent in 1991 and 4.9 percent in 1990. Nonetheless, the IMF cautioned the United States Federal Reserve to be ready to restrain money growth as the economy rebounds.The IMF acknowledged in its most recent World Economic Outlook report that the risk of higher inflation in the US and other countries recovering from recession "appears to be small" for now. However, the IMF added that "as these economies recover, the monetary authorities will need to remain vigilant and be prepared to tighten monetary conditions at an early stage, particularly if the expansion proves to be stronger than expected." This was good advice. The fact that the IMF statement conflicts with pre-election efforts by the Bush administration to jump-start the global economy does not make it less valid. Conventional wisdom in Washington and on Wall Street is that slow growth opens (or should open) the door to easy money. In a sluggish economy, the risk of inflation is low. Thus, central bankers should stress growth. This is a false choice. Except for short periods, there is no trade-off between inflation and growth. Easy money will not lead to sustainable increases in employment and real income - only to higher prices. The Shadow Open Market Committee points out that a modest recovery would have "lasting benefits." The SOMC - a group of economists (including this correspondent) that regularly comments on policy issues - warned that "rapid expansion would have less effect on jobs and domestic output" than most analysts assume. Reflation is out, but there are other options to foster expansion. IMF managing director Michel Camdessus says that cuts by industrial nations in military spending and farm subsidies would free funds for investment while avoiding higher interest rates. "We have the potential to match several times the new funding needs," he said. He added that if countries spending more than 4.5 percent of domestic output on arms cut outlays to that level, $140 billion would be saved annually. "Pernicious effects" of su bsidies in the industrialized countries cost another $100 billion a year, he said. He estimated that funds to rebuild the Middle East, for German reunification, and for reform in Eastern Europe and the Sovet Union would equal just six-tenths of 1 percent of the combined gross domestic product of the industrialized countries. Camdessus contended that the availability of savings to finance investment "is the central issue at the present time." He added that "the increase in savings needed to speed the transformation of the Soviet Union and Eastern Europe was less than" what could be saved through fiscal action. "If we don't do anything, the adjustment will happen through a rise in interest rates." These remarks were based on a fascinating study of financing needs by the IMF staff. These needs, the Fund estimates, could average $80 billion a year for the next five years. These requirements could total $100 billion a year during the period if "more ambitious" economic reform plans are implemented in the Soviet Union and Eastern Europe. This level of demand, the IMF said, suggests an increase in real global interest rates of about five-tenths of a percentage point, barring governmental action to reduce budget deficits. Of possible annual needs of $100 billion a year, $55 billion would go for German reunification, $33 billion to Eastern Europe and the Soviet Union, and $12 billion to the Middle East. Policymakers and market participants have been concerned about a potential shortage of capital. However, the IMF offered a useful lesson in elementary economics: New financing demands will not be "fully satisfied" even if rates only go up modestly. It won't take much of an increase in real rates to ration marginal players out of the market. The basic message was a breath of fresh air: Keep money growth low and stable. Cut public demand on resources. It is to be hoped the Beltway Gang will get copies.

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