Zero inflation.

Zero Inflation

FEDERAL RESERVE Chairman Alan Greenspan created a stir by announcing a goal of zero inflation within the next five years. Why should that be so controversial? Why should it be any more difficult to get inflation down from around 3 or 4 per cent to zero than it was to get inflation down from over 10 per cent to 4 per cent? Indeed, the central banks of Japan and West Germany have held inflation below 2 per cent for years, with many benefits and few sacrifices. The U.S. likewise held inflation below 2 per cent nearly every year from 1952 to 1967, albeit with the help of a (mismanaged) gold standard.

The Fed has already defied most mainstream economists by bringing inflation down more promptly than they thought possible. There are risks involved. Tight money might push prices down faster than costs, squeezing profit margins and resulting in plant shutdowns. The perception that the Fed really won't tolerate inflation also makes housing less attractive as a hedge against inflation, helping to depress housing prices in some areas.

But there are also very real benefits from maintaining a reasonably firm downward pressure on inflation. Long-term interest rates have declined, for example, and personal income and wealth are now rising faster than inflation. So far, the "Fed funds" interest rate on bank reserves has been allowed to drift gradually down from nearly 10 per cent earlier this year to about 8.5 per cent, as inflation moderated. The Fed is now under considerable pressure to push interest rates down much more rapidly, by giving the banks more reserves in exchange for Treasury bills. This is said to be necessary to avert an elusive recession, which has often been forecast but not yet seen. In this view, the Fed's job is to Fine-tune the real economy or the trade balance, which it cannot do, rather than to provide money the world can trust, which perhaps it can.

The risks of a weak economy have indeed increased, ever since Senate Republicans threw in the towel on capital gains. Loss of that expected tax cut has much the same impact as an unexpected tax increase--it reduces after-tax wealth and incentives. But it is not feasible to offset the damage of a tax policy that discourages supply by substituting a monetary policy that encourages borrowing and spending. Why use rapid credit creation to entice people to offer more money for goods that workers and investors have less incentive to produce? That is simply a recipe for stagflation. So long as the dollar is reasonably stable, commodity prices are not collapsing, and long-term interest rates are inching down, the Fed just might be bringing us toward Mr. Greenspan's zero-inflation goal more quickly and easily than anyone now imagines.