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Alan Greenspan’s Inflation Problem

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Federal Reserve Chairman Alan Greenspan has informed the American people that they can expect to see higher interest rates for the rest of the year. In his recent testimony before the Congressional Committee on Banking and Financial Services, Greenspan stated that the unprecedented growth in production and employment in the economy is a threat to the future stability of the country. And to meet that threat, America’s central bank will try to rein in growth by making it more costly for both consumers and businessmen to borrow.

Several times during the past year and a half, the Federal Reserve Board has increased the Federal Funds rate–the rate at which banks lend money to each other–to try to slow down the rate of spending in the economy. The rationale has been that the impressive expansion in the quantity of goods and services has produced an unstable boom in the stock market and is placing dangerous pressures on an already-tight labor market that threatens to set off a new wave of price inflation.

There is one big problem with Greenspan’s argument. It is the monetary policy of the Federal Reserve that has created the danger of inflation, not the productive energies of the American people. For more than 107 months, the U.S. economy has been growing due to technological innovation and increases in worker productivity, investment, and capital formation. The average annual increase in real goods and services over most of the last nine years has been between 3 percent and 4 percent or better.

Such a phenomenal trend of economic growth and productivity improvement has not only increased the amount of goods and services available to the consuming public; it has also been lowering the costs of production and manufacturing. What the American consumer should have been experiencing during this time was gently falling prices for the goods they buy on the market, reflecting those greater supplies and the lower costs at which they have been produced.

For some goods, prices have dramatically gone down. But nonetheless, during the last nine years, annual price inflation has still been averaging between 1.5 and 2 percent. And the economy has also been awash in financial liquidity to feed the giant run-up in the stock market that has had Greenspan so worried over the last few years. By several measures, the money supply has been increasing at seriously high rates over the last three years. Currency in circulation and basic reserves in the banking system available for lending purposes (known as the monetary base) has gone up in 1997, 1998, and 1999, by 5, 6.2 and 9.6 percent, respectively. Currency in circulation, checking accounts, and various types of time deposits and mutual funds (known as M-2) have increased during the same period, by 4.9, 7.3, and 7.5 percent, respectively.

During this time, the Federal Reserve, under Greenspan’s chairmanship, has expanded the money supply to prevent the American people from enjoying a higher standard of living through a wider circle of lower-priced goods. Consequently, it is Greenspan and the Fed who have actually created the danger of serious price inflation.

Yet it is American consumers and investors who are being blamed for the monetary mismanagement for which no one is responsible except Greenspan and the other members of the Federal Reserve’s board of governors. Unfortunately, it will be the American public who will be forced to pay the price for this monetary mismanagement if the Federal Reserve starts ratcheting up interest rates in the attempt to choke off the consumer and investor spending.

What was not asked of Greenspan at his recent congressional reconfirmation hearings for a third term as chairman of the Federal Reserve System was one essential question: Can the monetary and banking systems of the United States be entrusted to the central planning to the Federal Reserve’s nine-member board of governors? Or is it not time to rethink whether there might be some way to return the supplying of money to the marketplace? For example, the gold standard of an earlier time or, better yet, a totally free market in money. Why should the American people continue to rely on the limited knowledge and ability of a board of monetary central planners, no matter how well-intentioned?

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    Richard M. Ebeling is a professor of economics at Northwood University. He was formerly president of The Foundation for Economic Education (2003–2008), was the Ludwig von Mises Professor of Economics at Hillsdale College (1988–2003) in Hillsdale, Michigan, and served as vice president of academic affairs for The Future of Freedom Foundation (1989–2003).