Anna Schwartz: 'The Fed Is Inviting Inflation'

The noted economist Anna Schwartz is scoffing at suggestions that the economy is in a recession, and she is accusing the Federal Reserve of "ignoring" the dangers of inflation. "I think the Fed is inviting inflation by lowering rates to the extent it has," she said in an interview with The New York Sun yesterday. Ms. Schwartz, 92, who has worked at the National Bureau of Economic Research in New York since 1941, came to renown when in 1963 she jointly published with Nobel laureate Milton Friedman "A Monetary History of the United States, 1867-1960." The book revolutionized the understanding of the Great Depression, arguing that the Federal Reserve was to blame for the devastating crash.

The Fed is once again a central focal point as it struggles in balancing the need to stimulate growth while simultaneously controlling inflation. Since mid-January, the Fed has focused on spurring growth, aggressively cutting its key interest rate by 1.25 percentage points, to 3%. It is expected to cut as much as half of a percentage point at or before its next scheduled meeting, in March. Meanwhile, inflation has been on the rise. Core prices, which exclude food and energy, jumped 2.7% in the fourth quarter of 2007, up from 2% in the third quarter. This is the biggest quarterly increase since the spring of 2006 and far above the 2% inflation that is considered the upper reaches of the Fed's comfort zone.

"The Fed will face a time when they will have to raise rates unless they are going to permit inflation to keep going higher, and when that happens, they may do more damage to the economy than anything that is likely to occur now," Ms. Schwartz said.

Ms. Schwartz is not alone in her inflationary concerns. Speaking in Mexico City yesterday, the president of the Federal Reserve Bank of Dallas, Richard Fisher, gave his rationale for why he voted against the Fed's latest interest rate cut: "My dissenting vote last week was simply a difference of opinion about how far and how fast we might re-spike the monetary punchbowl," he said, referring to the famous statement by a former Fed chairman, William McChesney Martin, that "the job of a good central banker is to take away the punchbowl just as the party gets going."

Mr. Fisher, who was the only member of the Federal Open Market Committee to vote against the rate hike, said the Fed "has to be very careful now to add just the right amount of stimulus to the punchbowl, without mixing in the potential to juice up inflation once the effect of the new punch kicks in."

While some economists such as Mr. Fisher and Ms. Schwartz are focused on inflation, they may be in the minority. Yesterday, forecasting firm Global Insights joined economists from Goldman Sachs, Morgan Stanley, UBS, and Merrill Lynch in declaring the economy in a recession. In addition, the Bank of England cut its key interest rate by a quarter of a percentage point, and the European Central Bank, which has been staunchly opposed to cutting interest rates, indicated its stance was softening.

"While the economic fundamentals of the euro area are sound, incoming data have confirmed that the risks surrounding the outlook for economic activity lie on the downside," the president of the ECB, Jean-Claude Trichet, said. The bank held rates steady at 4%, but "We will continue to monitor very closely all developments over the coming weeks," Mr. Trichet said.

"The weight of evidence now suggests that the economy has slipped over the edge into a mild recession for the first half of this year," an economist at Global Insight, Nigel Gault said. The "most striking evidence" of a recession, Mr. Gault said, was Tuesday's Institute of Supply Management's services sector index, which fell by the sharpest amount since the ISM began keeping records. The index, which gauges how quickly that area of the economy grew or contracted from one month to another, came in at 41.9 — the lowest level since the aftermath of the attacks of September 11, 2001, and the first contraction since March 2003.

Ms. Schwartz dismissed forecasts such as the ISM figures as "unreliable and useless. I don't see evidence that the economy is on the verge of a recession." She added that while there is certainly a slowdown in growth, "there is a big difference between a slowdown in the growth rate and a negative growth rate."