Don’t Bank on It

Anyone familiar with central banks who read Edward Luttwak’s article [“The Real Masters of the Universe,” Outlook, Feb. 2] will wonder whether he is qualified to write on that subject.

I found seven factual mistakes in the first four paragraphs: The United States has not experienced an increase in inequality “forever and ever”; the Federal Reserve Bank of New York is not on Wall Street; the Bundesbank is not in a “compound outside Bonn” but in Frankfurt; central bankers do not have terms of “papal length”; Hans Tietmeyer has not retired as president of the Bundesbank; central bankers do not “receive their salaries from the taxpayers like all other government employees”; and Alan Greenspan was not the host at the Jackson Hole meeting last August. Later on, Luttwak mistakenly implies that the wages of all workers have been falling and labels Bob Dole’s tax cut proposal as “left wing” when, in fact, it reflected the beliefs of the conservative supply-siders. If Luttwak is that wrong about the simple facts, what basis does he have to form judgments on important policy issues?

Someone unfamiliar with what the Federal Reserve has been doing in recent years might infer from the article that it has been aiming either for zero inflation or for “deflation”—falling prices. One would not know that the Fed had tolerated an average inflation rate—as measured by the consumer price index, which is generally thought to overstate inflation by about one percent—of just under 3 percent per year in the past six years. In other words, Luttwak’s article is basically a straw man. He attributes to the Fed the view that “any inflation is worse than stagnation.” That is simply wrong, as the record shows.

He also misrepresents an article in the International Monetary Fund Staff Papers (March 1996). Luttwak says that it “found that inflation rates up to 8 percent were not harmful.” What the article’s conclusion says is: “When inflation is low, it has no significant negative effect on economic growth, and the effect may even be slightly positive. But when inflation is high, it has a negative effect on growth. The negative effect is robust, statistically significant, and very powerful. The point of the structural break was estimated to occur when the annual average rate of inflation is 8 percent.” That article is based on statistical analysis of 87 countries, most of which have had much higher inflation than the United States.

Whether the U.S. economy is capable of faster growth, which would basically require a speed-up in the rate of advance of productivity, has no simple answer. Both the Congressional Budget Office and the administration judge that the economy’s current growth potential is no higher than 2.25 percent per year. That is not exclusively a Federal Reserve assumption, but one would not know it from reading Luttwak.