Just past next Tuesday's election looms the next meeting of the Federal Reserve.  Indeed, decisions about monetary policy can be just as important as decisions made at the ballot box when it comes to the economy.

The Greenspan Fed boosted short-term interest rates in late 1999 and earlier this year.  Unfortunately, market indicators of inflation expectations did not justify such rate hikes.  The Fed seemed to fall back into the Phillips Curve trap-i.e., the misguided notion that economic growth causes inflation-which has no basis in economic reality.  Nonetheless, the Fed has been trying to engineer a so-called "soft landing," whereby the economy is slowed to dampen presumed inflation pressures while not allowing the economy to slip into recession.  Third quarter real GDP growth did slip considerably to an estimated 2.7%.

In reality, of course, inflation is caused by too much money chasing too few goods, which means that economic growth reduces the risks of inflation rather than increasing such risks.  Inflation results when the Fed does a poor job, and the growth in money supply runs ahead of money demand.

A key inflation indicator is the price of gold.  Yesterday (October 30), gold hit a 12-month low.  Obviously, the market does not see inflation in the cards right now.  The Greenspan Fed should abandon its misguided Phillips Curve thinking, and get back to looking to the markets for guidance.  The markets currently are signaling, at the very least, no further interest rate increases by the Fed.

However, the real risk today is that the Fed already has gone too far, and the economy might move into a mild case of stagflation-i.e., slower growth or recession and higher inflation.

Raymond J. Keating
Chief Economist
Small Business Survival Committee
and co-author of
U.S. by the Numbers:
Figuring What's Left, Right, and Wrong with America State by State