Courtesy Reuters

Full Steam Ahead: "Inflation Overkill" Revisited

For the past few years, the United States has enjoyed unprecedented economic growth. Warnings that inflation would kick in if the economy grew faster than 2.5 to 3 percent have proven wrong. The theory of "maximum sustainable capacity" has been shattered. Jobs have been created -- despite large corporations' restructuring and downsizing -- by an incredible surge in the growth of small companies, increasingly fueled by the Internet and cheap capital. Unemployment remains near historic lows, and much of the country has grown wealthier.

My September/October 1994 article in these pages, "Inflation Overkill," proposed that the U.S. economy could grow at five to six percent without incurring inflation. It also stated that inflation was not a threat then, nor would it be in the foreseeable future. The six intervening years have proven these observations correct. What was true in 1994 is equally true today. Yet many economists continue to focus on old economic and financial indicators, overlooking the power of a new anti-inflation weapon: competition. Competition -- brought about by trade and technology -- has stripped most businesses of their pricing power. And if businesses cannot raise prices (and cannot make price increases stick), there is no inflation.

Open markets that allow for more trade, together with better information technology, are the best allies the Federal Reserve and central bankers around the world have in their fight against inflation. Those two forces are more effective in controlling prices than the age-old tool of raising interest rates. Yet the Fed does not seem to agree: it has raised its key interest rate almost continuously over the past year. The presumption that the Fed must move faster than inflation to prevent it could become self-fulfilling. Remember, money is a commodity, so raising the price of money can cause the price of goods and services to go up, triggering inflation. Ironically, the only institution today that has the power to raise prices is the Fed.

Inflation happens when too much money chases too few goods and

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