It is not difficult to make a case for a tightening of Federal Reserve monetary policy at this time. Inflation creep is clearly evident in many measures that are more sensitive than overall price indexes. Fiscal policy is clearly turning stimulative in the U.S., as well as in Europe and Asia. Economic growth is exceeding the most optimistic expectations in the U.S., as well as much of the global economy. And the money supply is running way ahead of targets in the U.S. and, yes again, in most of Europe and Asia. Tapping the monetary brakes at this point in the business cycle is appropriate, and central banks everywhere are doing just that. So why did Fed Chairman Alan Greenspan confuse things by appearing to blame productivity for promoting excessive demand during his recent congressional testimony? Why did he then suggest that stock prices rise no faster than the growth in personal income in order to curb the wealth effect? On the surface, both ideas appear to be strange.

Actually, one is and one isn't. Greenspan's analysis of productivity does make sense, but only after it's tweaked. Greenspan has long argued that a technological revolution in the U.S. is increasing productivity, allowing for more noninflationary economic growth. Why? Because higher productivity leads to greater supply. But now Greenspan is also suggesting that higher productivity can generate demand that outruns supply. How? Because higher productivity can lift expectations of corporate earnings, stock prices, and household wealth. The result is a wealth effect, which can push the growth in demand to exceed the growth in supply.

What is essential to Greenspan's analysis is the sense of a global business cycle--a timing issue. Demand in the U.S. has exceeded domestic supply for much of the late '90s without igniting inflation. Excess demand has been met by importing goods and labor from the rest of the world where growth has been slow. But now the global economy is beginning to pick up sharply. Factories overseas are starting to sell to local markets, not just to the U.S. Demand for labor in Asia and Europe is tightening. This makes supplying an American economy booming along at nearly a 6% annual rate more difficult and potentially a lot more inflationary. Put Greenspan's argument about productivity leading to excess demand in the context of a global business cycle and it makes sense.

Greenspan's idea that the rate of personal income growth should place a straitjacket on stock prices doesn't make sense at any time, and certainly not now. Stock prices reflect current and anticipated corporate profits, which were up 19% in 1999, not far from the 22% jump in Standard & Poor's 500-stock index. Personal incomes rose 5.6% last year. Should the market have gone up only 5.6% despite the surge in profits? Had the Dow Jones industrial average tracked income in the '90s, it would be at about 5,000 today. Given the surge in New Economy growth and the fall in interest rates over the decade, it doesn't make sense.

We would prefer that the Fed spotlight the upward creep in inflation when making its case for raising rates. Inflation flags are flying everywhere. Core CPI, though still tame, is now beginning to rise in the U.S., Canada, France, and Germany. Commodity prices are up sharply, even excluding the higher energy prices. And most importantly, wage inflation is picking up as well in the U.S. and abroad.

Interest rates should be going up, perhaps even faster than they have been. But more clarity about why monetary policy should be tightening would help explain the Fed's moves to the market.

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