Controversy.

FOR months Alan Greenspan and many of his top lieutenants have been publicly grumbling about the inflationary dangers of too much growth, or stock prices that are too exuberant, or unemployment that is too low, or wages that are too high. People are working and prospering, and somehow this must be a bad thing. So, in the Fed's perversely pessimistic logic, interest-rate increases must be applied to stop the march of progress.

But free-market financial and commodity prices, always hyper-sensitive to the threat of currency devaluation and price-level increases, show there is not one whiff of inflation anywhere. Leading commodity indexes have fallen nearly 10 per cent over the past year. Gold and precious metals have dropped more than 12 per cent. The dollar has appreciated by roughly 15 per cent over the past year. Even the flawed consumer price index, which overstates inflation by 1 percentage point, according to the recent report of the Boskin Commission, registered a mild 2.8 per cent rise for the 12 months to March 1997.

Despite the flood of new evidence that recent years' extraordinary advances in high technology have increased worker productivity and enlarged the economy's capacity to grow, senior Fed staffers Donald Kohn and Mike Prell, along with a recent Clinton appointee to the Federal Reserve Board, Laurence Meyer, con- tinue to promote the Phillips Curve, an old-world Keynesian approach that asserts a trade-off between unemployment and inflation. In this model the cen- tral bank must identify and target the non-accelerating-inflation rate of unemployment, or NAIRU. When the actual unemployment rate falls below NAIRU, wages will be pushed up and inflation will rise.

The trouble is, this model has never worked. Milton Friedman long ago reminded us that inflation is a monetary phenomenon: too much money chasing too few goods, leading to a decline in money's purchasing power. What's more, the Fed has causality running from wages to inflation, when in fact history shows that rising inflation causes excessive wage hikes. Additionally, in the stag- flationary 1970s we saw that rising inflation, which saps growth, causes unemployment to rise. In the 1980s, declining inflation sparked higher returns on capital investment, improved the quality of corporate earnings, and raised real incomes, thereby lowering the unemployment rate.

When President Reagan appointed hard-money commodity-watchers Manley Johnson, Wayne Angell, and Robert Heller to work with Alan Greenspan, between 1985 and 1994 the Fed focused on free-market price-level indicators to gauge whether the money it supplied was excessive or scarce. Particular emphasis was placed on the price movement of gold, broad commodity indexes, the dollar exchange rate, and Treasury yield-curve spreads. The "price rule" approach laid the groundwork for a healthy economy, stable financial markets, and a low infla- tion rate. Over the past five years inflation has averaged only 2.5 per cent per year, while real GDP has advanced by 2.7 per cent per year. When govern- ment statisticians learn to measure accurately the effects of the high-tech transformation of the economy, the revised data will probably show about 3.5 per cent trend growth and less than 2 per cent inflation for this period.

If the Republican Congress gets around to reforming the tax code, ending the double and triple taxation of capital, savings, and investment, the same quantity of money will chase more goods and services, thereby creating faster economic growth accompanied by lower inflation. If the supply curve is pushed outward, the frontier economic growth rate and the unemployment rate could be sustained in the 4 per cent zone, with price stability.

LAWRENCE KUDLOW 

IN the bad old days, the economy was run by a bunch of Keynesians. They tried to use monetary policy to prevent interest rates from rising. Low interest rates and rapid money growth, they claimed, increased spending and thus cre- ated jobs, prosperity, and economic growth. They made a mess of the economy. By the early 1980s, many people had learned that the Keynesian prescription was bad medicine. Instead of growth and employment, we had rising inflation and rising unemployment.

Enter Ronald Reagan. To restore growth, he urged deregulation, lower tax rates, and a shift of resources from public to private spending. To fight inflation, he called for non-inflationary monetary policies. The program worked. The economy has experienced steady growth for 15 years, with only a relatively mild recession in 1990 -91. Inflation has fallen to the lowest level in thirty years.

Some of President Reagan's would-be heirs, including Newt Gingrich and Jack Kemp, have become supply-side Keynesians. Their criticisms of the Fed's recent rate increase neglect zero inflation, a major part of the Reagan program. Unlike them, President Reagan did not forget that a country cannot create more jobs or more growth by running the printing presses at higher speed. One rea- son that businesses have worked much harder to reduce costs in the low-inflation environment of the past few years is that they cannot cover their costly mistakes as easily as they could in the past by boosting prices.

Inflation is still with us. Fortunately it is at a much lower rate than in the early 1980s, but it is not zero. Money growth, on almost any measure, has been increasing for the past six months. And the increases here have been accompanied by faster money growth in Japan, and in Germany and elsewhere in Europe.

Inflation results when the sustained growth of money exceeds the growth of real output. The Fed's announcement cited "persistent strength in demand" as "progressively increasing the risk of inflationary imbalances." It didn't make the mistake of citing too much growth of supply or rely on some unreliable association between inflation and unemployment. For the present the Fed seems able to distinguish between growth of capital, labor, and productivity, which increases supply, and the too rapid growth of money, which pumps up demand. It is time for the supply-side Keynesians to do the same.

The recent increase in interest rates was a prudent move to slow the growth of demand by slowing the growth of the principal monetary aggregates. The risk that a percentage point increase in the very short-term rate that the Fed con- trols will end the expansion is practically nil. The risk that a failure to act would lead to higher inflation is neither negligible nor worth taking. The Fed did the right thing and may need to do more if it is to slow the growth of money enough to end inflation.

ALLAN H. MELTZER

Until recently, Fed policy under the leadership of Alan Greenspan definitely had helped the economy's growth in the 1990s for the simple reason that the central bank had focused its attention on achieving price stability and avoided ill-fated efforts to fine-tune the real economy. The Fed's success at lowering inflation and keeping it in check has been due to its de facto adop- tion of a "modified price rule" -- not explicitly tying monetary policy to the price of any particular commodity or price index, but instead gradually institutionalizing a reliance on market prices broadly conceived (e.g., pre- cious metals, commodities, the exchange value of the dollar) as the best means of detecting incipient inflation and calibrating monetary policy. Markets came to believe that not only did the Fed know what it was doing, but so did everyone else. Uncertainty was being eliminated from monetary policy because the Fed's actions were discernible from objective and measurable market fac- tors.

The Fed's recent increase in interest rates was wrong because it was totally unjustified by market indicators. The Fed appears to have abandoned its previously successful approach to monetary policy in favor of economic fine-tuning, resorting to the discredited Phillips Curve theory.

A free economy will not spontaneously exceed its capacity to grow and spin out of control into an inflationary spiral as the Phillips Curve holds. Inflation is caused by too many dollars chasing too few goods, not by too many people working. Inflation results when government prints too much money or leaves people uncertain about the future value of their currency. Far from being inflationary, real expansion of the economy soaks up inflation, creating more goods for the same amount of money to pursue.

Assuming the question uses "accommodating" to mean a Keynesian monetary stimulus to economic growth, the answer is, No. In fact, the original sup- ply-side prescription was to halt monetary accommodation (i.e., loose-money policy) and to significantly reduce money growth in order to squeeze inflation out of the economy; at the same time, regulatory relief, spending restraint, and across-the-board reductions in marginal tax rates were prescribed to create greater incentives to work, save, and invest and thus to accelerate real economic expansion.

The American economy's capacity to grow is at least 4 per cent a year, but it is diminished considerably by ill-considered government policies. An "accom- modating monetary policy" cannot compensate for the depressing effects of bad government policies. As Mr. Greenspan and I have both been arguing for more than a year now, eliminating the capital-gains tax would remove a government impediment that holds the economy back, so that the Fed would not have to fear inflation every time economic growth creeps above 2.5 per cent.

The best monetary policy would be to reattach the dollar to an anchor of gold. This could be accomplished immediately if Congress and the President were to instruct the Fed to stabilize the dollar value of the nation's gold reserves, say within a $30 band. Until we re-establish the dollar - gold link, the Fed's appropriate role is not to act as some kind of monetary chaperone, keeping the economy's growth behavior within proper bounds. The price mechanism is the economy's own internal governor, acting to keep demand within supply con- straints. Until we restore the dollar's anchor to gold, the Fed's appropriate role is to pursue price stability without regard to the real economy -- noth- ing more, nothing less. -- JACK KEMP

ANSWER #1: Monetary policy has generally increased U.S. economic growth in the 1990s. Low inflation increases the potential for long-term contracting by reducing price-level uncertainty. Moreover, in the years since 1977, a reduc- tion in the inflation rate has been followed by a reduction in the unemploy- ment rate within three years.

The recent increase in interest rates was a correct decision.

Answer #2: Supply-side tax policy should not be complemented by discretionary demand stimulus. The Fed is best advised to maintain a steady path of some nominal aggregate such as GDP or, preferably, domestic final sales, without responding to either favorable or unfavorable changes in supply conditions.

Commentary: I am amazed at how many conservatives are quick to criticize the one successful federal economic policy in recent years.

WILLIAM A. NISKANEN 

NR asked the following questions of several distinguished economists:

1. Has Federal Reserve policy helped or hurt the economy's growth in the 1990s? Was the recent increase in interest rates a bad idea?

2. Does supply-side policy require an accommodating monetary policy? If so, how does it differ from old-style Keynesian policy?