Call for 'robust' US to take rates hike ...

Back To Home Page

Call for 'robust' US to take rates hike pill puzzles economists

All the more curious, then, that the OECD should call on the US Federal Reserve to raise interest rates, as "an insurance against any re-emergence of upward trends in inflation". The recommendation seems to many economists an unduly cautious one and it was hardly surprising that the Clinton administration should hurry to condemn it.

Joseph Stiglitz, the chairman of the president's council of economic advisers, described the analysis that underpinned a call for a tightening of monetary policy as "mistaken", since it failed to acknowledge changes in the operation of the labour market in the past few years. He said that these had lowered the natural rate of unemployment, enabling employment to continue to expand without reigniting inflation.

"The combination of low unemployment and falling inflation is only possible because the natural rate of unemployment has fallen," he added.

But the main reason for the difference appears to be one of timing: the bulk of the OECD's report was prepared in the summer, when the evidence suggested the US economy was expanding rapidly and wage pressures had started to intensify. Since then, the economy has cooled and cost pressures have eased.

Peter Jarrett, the OECD's staff economist who prepared the report, acknowledged that the case for higher interest rates was "not all that clear-cut". But he argued the balance of risks was still asymmetrical and favoured a gentle tightening. There was little disagreement about the rest of the report, however, which is largely very positive.

The OECD applauds the Federal Reserve for engineering a "soft landing" by raising short-term rates in 1994. It points out that in terms of employment growth, the US continues to outperform all the leading industrial economies, thanks largely to its highly flexible labour markets. Investments remain strong as a result of a rapid increase in corporate profits, and the overhang in business inventories that developed during the first half of 1995 has now been corrected.

The public sector's deficit has been falling steadily as the share of general government consumption in national income has dropped by three percentage points over the past decade. The immediate outlook is for growth in gross domestic product this year of 2,4%, slowing slightly to 2,1% next year. Inflation as measured by the gross domestic product deflator, is expected to be lower in 1996 and 1997 than in any year since 1965. Unemployment is set to remain about 5,5%.

The report emphasises the need for progress on longer-term problems. The biggest is the likely deterioration in the public finances over the next few years. The federal deficit seems to raise again next year after several years of decline, and may reach $400 billion (R1 880 billion) - 3.3% of GDP - within a decade. The OECD urged the administration and the new Congress to renew their efforts to contain the cost of entitlement programmes such as social security and Medicare, the medical insurance system for the elderly. Though the labour market is among the most flexible in the world, the report says the risk of increasing polarisation of incomes is a serious one and urges further efforts to reduce income inequality. But it says the increase in the minimum wage approved this year is not the way to achieve that goal.

In a discussion of the US system of corporate governance, the report concludes that the case for abandonment of the traditional shareholder value-based system is unproven. It says the recent "downsizing" of US companies, far from demonstrating the weakness of the market-enforced focus on shareholder value, is evidence of "the dynamism of the US business sector, and the acuity of competition in product markets". - Financial Times

Top of page