The Blog

It's the Economy, Stupid

A look at what went right in 2005, and what might go wrong in 2006.

1:43 PM, Jan 3, 2006 • By IRWIN M. STELZER
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All of this cheer despite the likelihood that the Fed will continue to ratchet up interest rates. The new chairman, Ben Bernake, will not want to use his first day in the chair to bring the round of rate rises, thirteen so far, to an end. Good thing. Inflation, although not threatening to get out of hand, is close to the top of the Fed's 1-2 percent comfort range, despite the advent of $100 laptops, cheaper flat-screen television sets, and wild discounts on your favorite gas-guzzling SUV. An unemployment rate of 5 percent, or even lower, indicates a tight job market in which wage pressures are mounting, especially for skilled workers. Capacity utilization rates are now high enough for many board rooms to be treated to Power Point presentations about the return of pricing power, and for supply chain bottlenecks to be popping up. And OPEC has decided that, although $70 oil might threaten a demand-reducing recession and a shift from fossil fuels, $50 is a good, safe target number, more enriching than the $28 per barrel price the Saudis not so long ago promised to maintain as a ceiling.

So it would not be surprising if the Fed called a halt only after pushing rates to 5 percent, to the consternation of critics who fear a Fed overshoot. They correctly point out that the housing market is slowing, with mortgage applications down and inventories of unsold homes up, and orders for durable goods other than aircraft have been disappointing. True, too, we have not seen an end of the productivity miracle that continues to allow output to expand in a widening number of industries while unit labor costs are contained. And it is also true that the relationship between short-term and long-term interest rates is now such that many observers see a recession in the offing.

Those undeniable facts are grist for the mill of Greenspan's critics, who say that further increases in interest rates will repeat a frequent Fed error of raising rates further than is required to contain inflation, thereby spinning the economy into recession.

But the history of the past 18 years suggests that it is better to bet on Greenspan and the Fed than on his critics. Look elsewhere than the Fed boardroom if you want something to worry about in the New Year. A loony left-wing Venezuelan president shuts down his oil industry; China decides to unload some of its dollar hoard, driving the greenback down and interest rates to recession-producing levels; Congress continues to match trivial spending cuts with generous tax cuts, forcing interest rates still higher; the president's critics force a premature withdrawal from Iraq, leaving neighboring oil-producing countries at the mercy of anti-Western Islamists; the opaque hedge-fund industry precipitates a systemic banking crisis.

My advice: don't worry about things you can't do anything about. Have a Happy New Year.

Irwin M. Stelzer is director of economic policy studies at the Hudson Institute, a columnist for the Sunday Times (London), a contributing editor to The Weekly Standard, and a contributing writer to The Daily Standard. He has served as consultant to many energy companies and currently consults for a leading developer of wind farms.