Inflation battle: Soft landing or hard reality?

The year 2000 marked the 10th straight year of economic upswing, but it became a year of the Great Confrontation: Alan Greenspan vs. inflation. The issue: Are the good times too good? At a moment when the United States had seen its most prosperous moments ever, the Fed chairman feared that too much growth would ruin the economy. The nation's central bank wielded its power and leveled a series of quarter-point interest-rate hikes that hit the nation like karate chops; when those didn't work, Mr. Greenspan ordered a double dose, a half-point rate increase in May. The stock market corrected, credit card APRs spiked, and millions of dollars in assets were casualties in the fight for a soft landing.

But is it true that growth beyond expected levels always causes inflation? Opponents of this school of thought argue that with the world largely at peace and technology booming, Americans should be able to reap the full rewards of success. The argument is the loudest economic dispute since free-marketers rallied by Milton Friedman took on the tax-and-spend Keynesian establishment two decades ago.

This time around, Alan Greenspan has a trillion-dollar soapbox. He started the year complaining about the "wealth effect." With income and spending going up, there was more demand for more jobs at higher salaries, and inflation could result.

Many Americans thought 108 months of uninterrupted growth-and the lowest unemployment rates in 30 years-was a cause for celebration. Mr. Greenspan was cautious. In a March speech he proclaimed that "a vigilant Federal Reserve" must "effect the necessary alignment" of supply and demand. By the time the Fed was finished, the federal funds rate (that banks charge each other on overnight loans) was at the highest level in nine years. Tech stocks (real technology companies, not just dot-com stuff) trading on the Nasdaq exchange nose-dived, for that reason among many others.

By July, Mr. Greenspan announced that the economy was showing signs of slowing. Over the summer, a new problem popped up: Oil prices were soaring, hitting a 10-year high in September. By December, Mr. Greenspan said the U.S. economy had slowed "appreciably." He expressed concern that the economy was slowing too fast. Besides oil and stocks, he talked about reduced consumer and business spending.

"In periods of transition from unsustainable to more modest rates of growth," he said, "an economy is obviously at increased risk of untoward events that would be readily absorbed in a period of boom." Translation: Things may not be working as planned.

Here's a key question: Does a New Economy by its very nature create long-term positive effects so that some of the traditional cautions are no longer needed? Mr. Greenspan has even said that high-tech stocks could continue "to serve as an engine of strong productivity growth in the years ahead." This very point is precisely the one on which opponents attacked his anti-inflation saber-rattling.

Supply-side economist David Gitlitz of DG Capital Advisors proclaims that the truth is a zero-inflation reality. In an August report he argued that what experts see as the dollar's declining purchasing power is actually their inability to measure the forces fueling recent growth. "What is currently registering as inflation in the official data is in fact a statistical illusion," he said. Others beg to differ: The danger of inflation is real.

In just a few months, curiosity about a soft landing was replaced by fear of a recession. Credit is tightening. Corporate losses are rising. Stocks are down. A blanket of pessimism now covers cheerfulness about a long boom. Observers hope the Fed will lower rates soon to boost liquidity.

Some fear that deflation, not inflation, is a distinct possibility. The price of gold underperformed the Dow as usual this year. The dollar is still super-strong against other currencies, especially the struggling Euro. If Mr. Greenspan was pushing in the wrong direction, this is bad news. Rate changes take several months to filter through the economy; this means the hikes are still reverberating and any decreases won't necessarily reverse things quickly.

So far the economic fight has not moved over to the political arena. That may change soon. President-elect George W. Bush has promoted a $1.3 trillion tax cut as a bulwark against recession. An across-the-board reduction was a central plank of the Bush campaign, as he mocked his opponent's "targeted" tax cuts. Bills to eliminate the marriage penalty and change the estate tax were vetoed by President Clinton but will probably be revived soon.

The new president's plan is to drop the lowest tax rate to 10 percent from 15 percent and the highest to 33 percent from 39.6 percent. He would eliminate the inheritance tax, double the child tax credit to $1,000, and allow charitable deductions to non-itemizers. Mr. Bush also wants to allow young people to divert some Social Security taxes into private accounts.

Whether all this will become reality is uncertain. But if the economic noose tightens, look for public support to grow-despite the reticence of an evenly split Senate and a less-Republican House of Representatives.