The Fed Stands Alone As Recession Rescuer
IF the Federal Reserve steps on the gas, the economic car responds nicely.
That's what Christina Romer and her husband, David Romer, economists at the University of California, Berkley, found in a new study of post-World War II monetary policy.
``Monetary policy alone is a sufficiently powerful and flexible tool to end recessions,'' they write. ``In nearly every postwar recession, policymakers have been quick to discern the onset of recession and have responded to the downturn with rapid and significant reductions in nominal and real interest rates.''
That finding is reassuring. It means that the doomsayers' warnings of deep depression ahead are just blather. It indicates that, should the Fed tip the United States economy into a slump by the modest increase in interest rates since February, it can reverse its policy quickly and get the economy going again. The nation does not depend on fiscal policy - Congress cutting taxes or boosting spending - to boost business activity.
The Romers note in the National Bureau of Economic Research report that ``discretionary fiscal policy does not appear to have had an important role in generating recoveries.'' If fiscal measures were taken, they usually fell into place about the time the economy was turning up. These fiscal responses were usually limited to small actions that could be taken without congressional approval or for which congressional approval was easy to obtain.
``Thus,'' the Romers write, ``the historical record contradicts the view that fiscal policy is essential to ending recessions or ensuring strong recoveries.''
Good thing. With a $220 billion federal deficit anticipated this fiscal year, the White House would be hard put to find enough votes in Congress to pass a stimulus package.
Mr. Romer welcomes the Fed's new monetary restraint, a shift intended to forestall greater inflation. ``Waiting until inflation has gone up is not a good policy,'' he says. That is because it takes six months to recognize a higher inflation pattern, another three months to change policy, and then another six months before that shift has an impact on the economy.
So far, the economy shows no signs of accelerating inflation. Statistics released this week show that in the first half of 1994, wholesale prices have risen just 1.6 percent at an annual rate and consumers prices at a 2.5 percent annual rate. The consensus forecast of 50 economists surveyed by Blue Chip Economic Indicators puts consumer prices up 2.7 percent for all of this year and 3.3 percent in 1995.
The Fed assumes that if unemployment - at 6 percent in June - drops further, it will result in faster inflation. Workers can demand bigger wage hikes and management higher prices.
Michael Keran, chief economist at Prudential Economics, holds that the Fed has overstated the risks of inflation. ``There is still substantial excess capacity'' in the economy, he maintains. So he expects inflation to continue falling this year and next.
Richard Hokenson sees inflation in a long-term secular decline, bottoming out at between 1 percent and 1.5 percent a year sometime in later 1995 or in early 1996. The chief economist at brokerage house Donaldson, Lufkin & Jenrette argues that strong capital spending per worker will so increase productivity that management will not need to raise prices as much.
If these two prove right on inflation, the Fed can then ease monetary policy to move the economy faster, Romer says.
The recent slowdown in money growth is one factor that causes some twinges of concern among economists. A narrow measure of money, M-1, that includes checking deposits and currency, has been rising at a 1.6 percent annual rate in the past few months. That compares with about 10 percent in the last half of 1993. M-2, a broader measure that includes some savings, has shrunk since March.
Because the linkage between money and subsequent growth in the economy has been weak in the past decade, the Fed no longer pays much attention to ``monetary aggregates.'' But William Poole, a Brown University economist, told a Boston Fed conference last month that ignoring the money supply ``could come back to haunt us.'' Robert Parks, a Wall Street economist, already worries about a ``growth recession'' ahead.