How can you predict Federal Reserve policy in a world of stagflation?

Easily. During times of severe unemployment and no inflationary pressure, look for lower interest rates.

Conversely, with operations close to capacity, unemployment low, and inflation a continuous threat, hold your hats and watch the cost of money rise.

Today we have inflationary pressures reoccurring, while at the same time unemployment is serious. So what might we predict?

Where's That Crystal Ball?

No economist maintains a good track record for predicting movements in Fed policy. Today's heroes are tomorrow's goats. My only claim to fame as a prognosticator is that of all the economists who have been wrong, I am at least the loudest.

Having admitted that, I will venture to say that the Federal Reserve's next move will be toward tighter money, rather than toward lower interest rates.

Why?

The first reason is a gut feeling stemming from the fact that the Federal Reserve is by its nature a conservative body.

Its role has been described as that of the host who waits until the party gets to be fun and then takes away the punch bowl.

So if it must choose between fighting inflation and fighting unemployment, it fights inflation. The Fed knows that it is the only body taking this step, while there are lots of politicians and others who are impatient to fight against unemployment - largely with taxpayer money.

But there are two other reasons why this columnist thinks the next move in interest rates has to be upward.

Specter of Inflation

First look at the demand for funds from the Treasury to finance the deficit and to complete the savings and loan bailout. To provide enough bank reserves to both accommodate this Treasury demand for funds and also allow interest rates to fall further would take a huge influx of credit.

This is an influx that would exceed what an inflation-shy Fed would want to pump into the economy and also is far more than foreigners are willing and able to finance in the way they used to before the worldwide recession hit.

Spur to Buying?

But more important, there is the real question of whether pumping reserves into the economy in increased quantities would do any good.

Let's see why.

We all know the truth of the following: "Federal Reserves policy is like a string - it can pull but it can't push."

Could further easing of credit and lowering of interest rates really help the economy to recover?

I think not.

For instance, could lower interest rates help housing? Housing already is benefiting from the lowest interest rates in well over a decade. But from this point forward, it is unlikely that further lowering of interest rates could help builders sell new house.

The problem today is not the cost of financing a home. Rather, it's that would-be home-buyers must have a job and must hold onto that job in order to repay a mortgage and have the additional funds necessary for maintaining a house.

As for consumer spending, the level of interest rates has never been a major factor whether people will borrow to spend or not. The way most consumer borrowers feel is that "if interest rates rise, I don't pay more, I just pay longer."

Doesn't this help explain why bank credit card outstandings could soar even while rates charged on the cards remained near record highs?

Basic Economics Rule

What about business borrowing? As with housing, if the basic economics are not right for borrowing and spending, no decline in interest rates can help. If I have a year's supply of unsold inventory, I will not borrow to buy more because the cost of money dropped.

In sum, interest rate declines by themselves cannot bring recovery.

In the 19930s, we even had negative interest rates at times. That's right, people would pay the Treasury to take their money.

That's because the money paid the Treasury was less than the person would have had to pay on the assets if they were in any form other than Treasury securities, which are exempt from state and local taxation. Yet the Depression remained.

Sure, lower interest rates can't hurt a recovery. And if our choices could include lower rates that would only help the recovery a little but with no inflationary consequences, we would try them. But this is not today's situation.

So despite my rotten forecasting record, I proclaim today that fiscal forces can help bring recovery. But since a Fed monetary policy of lowering rates further would not be very effective and could bring back inflationary pressures, the Reserve authorities will not push rates lower.

Luckily for me, people don't save today's newspaper unless they're planning to wrap fish in it.

Mr. Nadler is a contributing editor of American Banker and professor of finance at the Rutgers University Graduate School of Management.

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