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Jewish World Review Dec. 28, 1999 /19 Teves, 5760

Lawrence Kudlow

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They missed it -- IS IT POSSIBLE that the Fed's arcane use of language has fooled even the vast army of Wall Street and news media Fed-watchers into missing an important new signal contained in last Tuesday's announcement?

Within that announcement, there seems to be a nugget or two that might infer a softer stance on future interest rate hikes. Might the Fed be backing off from its recent attacks on growth and jobs?

From the December 21 Fed press release that indicated no policy change in rates or bias, note the artful phrase " . . . the Committee remains concerned with the possibility that over time (italics mine) increases in demand will continue to exceed the growth in potential supply . . . " Only a possibility? This is new.

A month earlier, in their 25 basis point tightening announcement dated November 16, the operating phrase read " . . . the expansion of activity continues in excess of the economy's growth potential." In other words, they believed so-called "excess demand" was in fact definitively present, so they tightened. Not a possibility, but a fact, at least in their view.

A month before that, in their tightening bias announcement of October 5, the operating phrase stated " . . . the growth of demand has continued to outpace that of supply . . . " Again, not a possibility, but a fact, at least from the Fed's analysis (however misguided) of the economy.

Here's another interesting shift in language. In the October and November announcements, the Fed went out of its way to emphasize tight labor markets and the so-called decreasing pool of available workers.

However, in the December 21st statement released at 2:15 p.m. last Tuesday, the Fed made no mention of labor market tightness. Perhaps they are responding to the moderation of wage growth, which disproves the labor shortfall theory.

Or, maybe Greenspan & Co. actually read the recent Urban Institute study that shows a complete lack of factual evidence for the alleged Phillips curve trade-off between unemployment and wage growth among the ten lowest and ten highest state unemployment rates (see my recent piece, "Dracula's Curve").

My reading of the Fed's language shifts, both what they put in and what they left out, suggests a kinder and gentler approach to year 2000 credit policy. In particular, the phrase "possibility that over time" could be interpreted as a softer statement of rising interest rate intentions than most observers seem to think.

From this, a case could be made that the central bank is now more inclined to adopt a wait-and-see attitude about next year's economy, inflation and interest rates. In a sense, they may be telling us that they've done their work for now -- taking back 1998's three rate cuts -- and they expect to chill out for a while to see how future events play out.

If so, then futures markets and bond traders who expect a 50 to 75 basis point interest rate tightening early next year may be too pessimistic.

After all, reported inflation -- which I believe is still a more important Fed decision variable than unemployment or economic growth -- remains low. Fed fears of excess demand and labor shortages have not played out into higher inflation. Ultimately, without higher inflation reports, the Fed can have no brief against the rapid growth of the new information economy.

The latest 5.7% growth update for third-quarter gross domestic product was accompanied by a low 1.1% inflation rate. Strong growth and minimal price increases. What a great country. The overheating theory held dear by senior Fed staff and the platoon of demand-side economists on Wall Street is being blown out of the water.

What's more, the last twelve months consumer price index, ex-energy, shows only 2% inflation, actually less than 1998's performance. Oil prices look to be peaking, and could ease toward $21 bbl next year. If so, then the overall CPI rate will slow markedly.

Fast-forward market-based inflation signs, such as low gold, trendless commodity indexes, a strong King Dollar and a very flat Treasury yield curve, all suggest that money is relatively scarce, not excessive.

In the price rule model developed long ago by classical Swedish economist Knut Wicksell, stable commodity and financial market indicators would suggest no need to change the central bank rate. In today's context, the current 5 1/2% fed funds rate is sufficient to restrain inflation.

Taking all this into account, let me wonder out loud whether Mr. Greenspan all along this year has been using Keynesian language ("excess demand") mainly to keep Laurence Meyer and the Phillips curvers on the reservation. Think of it as team play, without public carping.

Meanwhile, the chairman himself pursues the undercover goal of an inflation-target price rule (though I wish he would announce this publicly). Sort of a clever CIA-type counter-intelligence operation, not unheard of in the Washington bureaucratic turf wars (where intelligence is countered at every turn).

Then again, the great reality today is the technology-driven Internet economy that is throwing off massive economic and investment returns that are increasing intelligence and countering inflation (more money chasing even more goods and services). This is what the yearend Nasdaq rally is telling us; market prices contain more information than econometric forecasts.

The Internet is more important than the Fed, both now and for years to come. Possibly, Mr. Greenspan has come around to accepting this view, including the deflationary pricing that is central to the Internet model of the economy.

If so, then the Fed's wait-and-see message last Tuesday was an unexpected holiday season gift. Perhaps the chairman is not our Malthusian-in-chief after all.

JWR contributor Lawrence Kudlow is chief economist for Schroder & Co. Inc and CNBC. He is the author of American Abundance: The New Economic & Moral Prosperity. Send your comments about his column by clicking here.


12/23/99: Bonditos
12/20/99: Dracula's Curve
12/16/99: When Alan Greenspan sneezes, Wall Street economists catch cold
12/10/99: Y2K-Related Cash
11/23/99: Y2K Money: Inflationary or Not?
11/16/99: Investor Retaliation
11/05/99: Rosy Lives
10/29/99: Drain Reserves
10/22/99: Supply-Side Is Mainstream
10/14/99: Y2K will likely bring more prosperity
10/07/99: Clinton's tax-cut veto
10/01/99: What's really bugging the stock market?
09/23/99: Growth Trade
09/09/99: Bad Dollar Logic
09/09/99: Buttered bread
08/31/99: Bull Market Alive and Well
08/26/99: Let Prices Rule
08/19/99: Blame OPEC, Not Growth

©1999, Lawrence Kudlow