The Fed Could Raise A Little More Keynes

You might call it a central banker's nightmare. The vice-chairman of the Federal Reserve Board declares unabashedly that he is a Keynesian. Moreover, he invokes the Nixon dictum of two decades ago that "we are all Keynesians now." Then he proceeds to admonish the guardians of the world's monetary system to stop fixating on inflation and start doing something about high


It was fo dream. That's what Alan S. Blinder, President Clinton's recent appointee to the Fed, told a high-powered audience of the world's central bankers and economists at a symposium last week in Jackson Hole, Wyo., organized by the Federal Reserve Bank of Kansas City. Blinder said that high European unemployment rates--81/2% in Germany and 12% in France--were not structural in nature, as the European central bankers claimed, but rather remnants of the recent recession. He argued, therefore, that two to three percentage points could be lopped off the unemployment rates by easing monetary policy--without raising inflation.

Should the Fed be practicing what Blinder is preaching to the Europeans? No, says the vice-chairman. Unlike Europe, U.S. unemployment, now at 6.1%, is almost to the point where easing money would ignite inflation. The implication was clear: The Fed was on the mark in raising short rates for a fifth time this year on Aug. 16, a move that Blinder supported in his first vote as a Fed member.

INFLATION GENIE. But Blinder may be wearing blinders when it comes to the U.S. economy. There's a convincing case to be made that U.S. unemployment could fall appreciably without letting the inflation genie out of the bottle. At issue is what economists call "the natural rate of unemployment." Here's the idea: Unemployment tends to move toward its natural level, much as water seeks its own level. If employment surges--and pushes the unemployment rate below the natural rate--then wages and prices start to climb.

Blinder argues that today's unemployment is about at its natural rate. And Edmund S. Phelps of Columbia University told the conference that the natural rate had risen to 6.5%.

True, the natural unemployment rate is higher than it was 40 years ago. In the 1950s and early 1960s, economists put it at 4%. Because more women were working and unemployment benefits were rising (allowing people to stay jobless longer), the rate increased by the early 1970s to perhaps 5.5%. But the 1994 Economic Report of the President prepared by the Council of Economic Advisers, of which Blinder was a member until his Fed appointment in June, concluded that "there was little evidence of any increase since then." Listen to Blinder in January at the American Economic Assn. meetings: "Is the natural rate 6% or higher? We do not accept that. We use a number closer to 5.5%. And that makes a difference."

In fact, the natural rate may be even lower than that, as forces in the economy drive it downward. So much so that the U.S. economy may be less inflation-prone than at any time since the 1950s. Over the past five years, more than 5 million immigrants have crossed U.S. borders. This wave of newcomers is putting a lid on wages, even as total employment surges. And the big gains are coming in such service jobs as retailing, which is almost entirely nonunion. Wage pressures there are largely nonexistent.

Just as important is the effect of trade on the U.S. economy. True, imports come to only 12% of gross domestic product, but that understates their impact on wages and prices. Cheaper imports force down prices of domestically produced goods and thus keep wages in those industries from rising.

The indirect effect of foreign competition is also potent. The threat of production moving overseas keeps workers from demanding higher pay. Even such services as computer programming are taking the heat, especially from India, notes Albert M. Wojnilower of CS First Boston Investment Management. "The natural rate may be a lot lower than the current jobless rate, and the gains from letting it get there could be enormous," he says.

More evidence of this thesis: If unemployment is at the natural rate, then prices should accelerate. That's simply not happening. The consumer price index shows a 2.8% rise over the past 12 months, the same as in the previous year. And the core rate of inflation, which excludes food and energy, rose 2.9% during the last year--down from 3.2% a year before.

All this suggests that employment can continue to grow smartly before wage and price pressures develop. The Fed should consider the advice its vice-chairman gave the Europeans. A wee bit of Keynesianism is in order.

Before it's here, it's on the Bloomberg Terminal.