TIME: Almanac 1995

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<text id=89TT0616> <title> Mar. 06, 1989: Feeling The Heat </title> <history> TIME--The Weekly Newsmagazine--1989 Mar. 06, 1989 The Tower Fiasco </history> <article> <source>Time Magazine</source> <hdr> BUSINESS, Page 50 Feeling the Heat </hdr><body> A burst of inflation rattles the stock market, sends interest rates bolting, and threatens to put the Fed and the White House on a collision course By John Greenwald Has the economic bane of the 1970s returned to haunt the late 1980s? For several years, inflation has seemed like a vanquished problem of another era. Price increases during the past half-decade have been remarkably small, never more than 5% annually. Vigilant economists have spotted warning signs from time to time but never any present danger. Now, however, comes fresh evidence that inflation may be making a comeback at a time when it could play havoc with the aging economic expansion and the new Administration. A serious rise in prices would force the Federal Reserve to fight back by pushing interest rates higher, which runs the risk of choking the economy, boosting the federal budget deficit, and ballooning the cost of President Bush's savings and loan bailout. The primary U.S. inflation signal flared brightly last week. Propelled largely by the fast-rising cost of food and gasoline, the Consumer Price Index increased 0.6% in January, which would amount to a worrisome 7.2% if it were to continue through the year. That marked the strongest monthly inflationary surge since January 1987, when prices jumped 0.7%. But the rate then slowed to a modest 4.4% for 1987 and 1988. After the latest numbers became public, Federal Reserve Chairman Alan Greenspan gave moneymen an anxiety attack by his frank acknowledgment of the problem. Testifying before Congress, Greenspan called the CPI report "disturbing" because it suggested that the U.S. economy was close to overheating despite the Fed's eleven-month effort to slow it down by subtly tightening the credit supply. Noting that last week's report followed January's startling 1% rise in the Wholesale Price Index, a leap of 12.7% on a compounded annual basis, Greenspan warned, "If inflation re-emerges, I think a recession will move up on us much more quickly than we can imagine, and when it occurs it will be a prolonged one." The inflation news sent tremors of alarm through homes, offices and executive suites, where memories of the inflation battle of 1981-82 still linger. Those fears were quickly rekindled when major banks, led by Chase Manhattan, boosted their prime lending rate from 11% to 11.5%, the second increase in two weeks. At week's end the Federal Reserve confirmed the quickening trend by raising its discount rate, which is the rate it charges banks for short-term loans, from 6.5% to 7%. Anticipating the effects that rising rates will have on business and the economy, the Dow Jones industrial average plunged 42.5 points in one session after the inflation numbers were released last Wednesday. Over the course of the week, investors sent the Dow falling to 2245.54, down 79.28 points. The CPI report cast a spotlight on the quiet but crucial duel between Greenspan and George Bush over U.S. economic policy. In its stand against inflation, the Fed has resolutely tightened credit since last March, when the prime rate stood at 8.5%. But Bush, even though he pledged during the fall campaign to drive inflation down to 2%, insisted two weeks ago that he is not "overly concerned" about the threat of rising prices and cautioned that he "would not like to see" the Fed push interest rates higher. In Tokyo last week, Bush asserted that the Fed might be overreacting to the inflation report. Said he: "I don't think you can make a judgment on one month's figures." But the President added that while he and Greenspan have "got a little difference of interpretation" about the data, "that's the only difference we've got." Nonetheless, the separate perceptions that divide the White House and the Fed remained glaringly obvious. On the day before the CPI figure was released, Greenspan told Congress that "the current level of inflation, let alone an increase, is not acceptable." But on the same day, Michael Boskin, chairman of Bush's Council of Economic Advisers, testified, "I do not yet see a serious increase in the underlying inflation rate." Boskin edged a bit closer to the Fed chairman by adding that if prices do begin soaring, the Administration will "take quick action" and "support a policy that avoids an acceleration of inflation." But as Greenspan battles inflation with a tight monetary policy, he will present the Administration with serious handicaps in meeting its fiscal goals. Any jump in borrowing rates would raise to even more astronomical levels the huge cost of bailing out the S & L industry. While the Administration put the total ten-year price tag at $90 billion when it announced its rescue plan last month, that forecast was swiftly raised to $126 billion. Last week Treasury Secretary Nicholas Brady said the cost is now expected to reach $157 billion. A spurt in interest rates could make even that projection seem unduly optimistic. The higher rates would boost the Government's cost of borrowing for the bailout, as well as worsen S & L losses by raising the interest that the thrifts must pay depositors. To calm fears of a possible run on deposits, Greenspan said last week that the Fed will provide cash to any insolvent S & Ls that need it to meet withdrawals. Most important for Bush, runaway interest rates would cast a pall on the Administration's sunny outlook for economic growth, which is central to its plans to cut the budget deficit. The White House expects the economy to expand by a robust 3.3% in 1989, vs. the 2.7% growth rate predicted by a consensus of top private forecasters. The Administration's scenario for a fast-moving economy would raise more than $80 billion in fresh tax revenues and help Bush meet the $100 billion deficit ceiling mandated by the Gramm-Rudman law for fiscal 1990. But Bush may be handing over the economic throttle to Greenspan by failing to take any tough deficit-reduction measures that might remove the heat from prices and interest rates. The Administration has little real chance to hit the Gramm-Rudman target without a tax increase, which Bush has ruled out, or politically unpopular spending cuts, which the President seems loath to initiate. Bush's strategy of leaving the hard choices to Congress has led so far to budget gridlock. Concedes a senior Administration official: "If Congress accepts our budget, economic growth and inflation and interest rates will take care of themselves. But if the bickering drags on, the Fed is going to give us all a hard time." Across the Atlantic, European financial leaders were startled by the signs of U.S. inflation and the budget stalemate, which they fear could lead to an eventual global slowdown. In a joint statement, France and West Germany pledged to coordinate efforts to keep their inflation rates in check. Said William Martin, chief economist for Phillips & Drew, a leading London brokerage: "Bush hasn't made any headway, and there is enormous skepticism about his progress." That lack of movement has left Greenspan little room to waver in the battle to keep inflation from getting out of hand. U.S. factories are running at near peak capacity, and unemployment has been at a 14-year low. The rising costs of production have prompted some experts to fear that an inflationary wage-price spiral could be ready to begin. Still, Fed watchers say Greenspan has the savvy to brake the economy without skidding it into a recession. Many credit the Fed with helping prevent a slump by easing credit after the 1987 stock crash. "Ever since the market meltdown, Greenspan has been walking on eggs," says Pierre Rinfret, a New York City-based economist. "He's making every move very cautiously." Greenspan seemed determined to maintain that cautious pace. While he and Bush share a long acquaintance and are described by aides as "very comfortable" together, the Fed chairman vowed to continue his efforts to reduce inflation. When Colorado Democrat Tim Wirth noted that the Fed seemed to be caught in the midst of a dangerous "high-wire act," Greenspan solemnly replied, "It is." Unless the Administration and Congress can find a credible way to cut the budget deficit, the Fed's daredevil performance will remain the only act in town. </body></article> </text>