The Economy Is No Runaway Train

Alan Greenspan called it irrational exuberance. But sometimes it looks more like exuberant irrationality. The Federal Reserve raises short-term interest rates and the stock market goes up, not down. Despite five tightening moves, rates on government securities move lower, not higher. As for the real economy, it careens ahead at a 6% to 7% growth rate, despite efforts to rein it in. Confusing musing about productivity and wealth by the Fed chairman leave investors cross-eyed. Are things a bit out of control? Or do they just seem to be?

The facts show that the U.S. economy really is on fire. Most everything is accelerating--consumer spending, business investment, corporate borrowing, private debt, commodity prices, money supply, fiscal stimulus, profits. Fast growth is pulling in so many imports that the trade deficit is at 4% of gross domestic product, a record.

The one exception is inflation. Yes, there are signs that the rate of inflation is no longer falling, but inflation creep is still very low by any historical standards. Unit labor costs are actually falling across most of the economy.

It all gets back to the question of just what is the safe speed limit for the U.S. economy. The truth is that New Economy advocates (and who isn't these days?) who were comfortable with noninflationary growth accelerating from 2 1/2% to 3 1/2% are just plain nervous about growth barreling along at 6%. The country had 3%-to-4% annual growth during the 1950s and '60s. It has never had 6% growth for long without igniting inflation.

Should we worry? A little. Productivity, too, is accelerating. Amazingly, 10 years into this expansion, there are signs that it may actually be rising at 3 1/2% to 4%. If that is true, then a 6% growth rate for the economy may be too fast, but still is nothing to panic over. A continuous, gradual tightening by the Fed should work fine. Don't forget, in 1994 it took seven moves by the Fed and a hike of three percentage points to slow the economy, and we are only halfway to that level. The economy may not be out of control. It may just seem that way.

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