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Trying to Read the Fed Chair's Two Minds on Interest Rates

May 04, 1997|TOM PETRUNO

Diary entry of Alan Greenspan, Friday, May 2, 1997


Dear Diary: Andrea and I had a great honeymoon, but now comes the downside: culling through our wedding gifts and writing thank-you notes. You wouldn't believe how many of our Wall Street friends gave us glass, marble or bronze sculptures of a bull fighting a bear. Sheesh--how creative are these guys?

Anyway, I'm also thinking a lot about the May 20 Fed board meeting, of course. And after last week--well, who knows what to think!

I guess Americans assume I have a crystal ball for interest rates and the economy, but the truth is I sometimes get just as confused as everyone else. I'm looking at the same mixed-up data they are, after all. Why do they think I talk in circles at those congressional hearings?

Last week I, like many people who pay attention to this stuff, was stunned by the small, 0.6% rise in the first quarter's employment cost index, a government measure of total compensation growth--including wages, salaries and benefits--across the broad economy.

I've been harping about the tight labor market for months, because many of the reports I get from our 12 regional Federal Reserve banks point to the trouble employers are having finding, and keeping, workers. Wouldn't you think compensation costs would be rising more rapidly than the 2.9% they were up in the year ended March 31--especially with the economy's red-hot 5.6% growth rate in the first quarter, the fastest in a decade?

Then came Friday's April employment report. Go figure! The unemployment rate drops to a 23-year low of 4.9%, but production workers' average hourly earnings actually are a penny lower than in March, at $12.14.

On top of that, Clinton and congressional leaders announced that they've got a balanced-budget plan. I'm as skeptical as anybody that this plan will do the job, but financial markets evidently aren't: Bond yields fell to eight-week lows Friday, and the Dow Jones industrial average soared 94.72 points to 7,071.20--just shy of its all-time high of 7,085.16.


So I know what people are thinking now: "Greenspan is a chump!" They think that I had no good reason to raise interest rates March 25 and that I certainly have no reason to raise rates again on May 20. The markets are telling us that the economy is just fine and will only get better if Uncle Sam finally balances his checkbook.

Americans think I'm a reactionary; they think I don't understand how the world works today.

Last year, I gave the economy the benefit of the doubt, leaving interest rates alone even after the economy grew at a strong 4.7% pace in the second quarter. Sure enough, growth ebbed again in the third quarter before rebounding again in the fourth.

More important, we never saw price inflation begin to accelerate as feared last year, even though by some measures workers' earnings in 1996 rose at the fastest rate since 1990.

It's the same basic story this year: There's no significant price inflation at the grocery store, the department store, etc. Heck, Big Macs are now 55 cents at McDonald's! If it wasn't for my cholesterol count, I'd probably be wolfing them down the way Clinton does.

Of course, I understand the forces at work here. For one, worker productivity is almost certainly better than what the government's measures of it show. All that technology equipment sold over the last six years must be doing some good. If people can produce more in less time, we get good growth without the need for companies to raise prices--and workers can be paid more, to boot.

Then there's the globalization of free trade, or at least freer trade, in the 1990s. Everybody on the planet is a capitalist these days except Castro and that guy in North Korea, what's-his-name. I know it's tough for most companies to think about raising prices because someone somewhere in the world may quickly step up and offer a cheaper product.

The strong U.S. dollar is just punctuating that issue for American companies this year. It's no coincidence that Toyota, Honda and BMW saw their U.S. car sales rise in April, while Chrysler and GM saw sales decline. If that forces U.S. auto makers to cut prices or offer rebates in the months ahead, there's another blow struck for low inflation.


Who's to say this great environment can't continue for another couple of years? Look at the Europeans--they're just beginning to get the idea that their companies have to be competitive, keep prices low, boost productivity, etc. In China, that massive labor force has only begun to be tapped for world production (and for consumption, too, I might add). And what if the Russians and the Indians get their acts together? How competitive might they be with us?

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