The Fed Is Deflationary
Jude Wanniski
September 2, 1999


Letters Editor
The New York Times
New York, N.Y.

Dear Editor:

Alan S. Blinder's op-ed on August 24 defending Chairman Alan Greenspan's record at the Federal Reserve makes one point that separates Keynesian economists from both supply-side economists and monetarists. Mr. Blinder, who served as vice chairman of the Fed in the mid-1990s, notes that "almost every American recession since World War II has been preceded by tighter monetary policy -- that is, higher interest rates."

Those of us who believe inflation and deflation are monetary phenomena do not believe that "tighter monetary policy" necessarily equates with higher interest rates. A tight monetary policy is one that denies the economy liquidity it needs to grow -- liquidity being cash and bank reserves that are non-interest-bearing debt of the U.S. government. When this occurs, the dollar price of gold declines, and in this sense, the Fed has been stingy with liquidity for more than two years. This is monetary deflation. When the Fed pushes more liquidity into the economy than it wants, i.e., "printing money," in common parlance, the result is monetary inflation.

Raising or lowering the overnight federal funds rate, the one interest-rate the Fed controls, may have a secondary effect on the supply of and demand for liquidity that results in an incipient inflation or deflation. But that often is accidental. The 35% decline in the price of gold since November 1996 is a sign of scarce liquidity, which has its first effect on bringing down other commodity prices. Corn, soybeans and wheat all are down at least that amount over the same period. The American Farm Bureau and the Farm Journal will confirm that I warned them two years ago that the Fed was making an error that would harm commodity producers worldwide.

Jude Wanniski