Last May, the Federal Reserve hiked interest rates by half a
percentage point, the sixth and final act in a campaign to stamp out
perceived inflation that stretched from mid-1999 to mid-2000. At the
time, the media applauded: "The biggest Fed rate hike in five
years," announced NBCís Mike Jensen on the May 16 edition of
Nightly News. "Good for the economy, good for Wall Street, but,"
Jensen allowed, "another blow to borrowers."
After a 22-year career with NBC,
Jensen retired on December 15, so he wasnít around to revise and
extend his remarks in the wake of the most recent meeting of the
Federal Reserveís Open Market Committee (FOMC) on December 19. The
past seven months have offered considerable evidence that the Fedís
May rate hike may have been the straw which finally broke the
- Unless shoppers race to the malls on Christmas Eve weekend and
really start spending, retail sales growth will be the weakest in
several years. "For the holiday shopping period, sales are down
8.2 percent, compared with the same period last year," the
Christian Science Monitorís Ron Scherer
reported on December 20.
- Major technology companies such as Microsoft, Sun
Microsystems, Cisco, Hewlett-Packard and IBM have seen significant
declines in their overall market capitalizations, as warnings of
flat or declining earnings have provoked intense investor selling
over the past few months. Also under pressure from the Clinton
Justice Department, shares in Microsoft ó once the largest company
in the world ó have dipped from a high of nearly $112 on March 23
to less than $42 a share, a 63 percent decline in only nine
- And itís not just the technology sector: "Profit troubles that
used to be confined to tech companies have spread to appliance
makers (Whirlpool), consumer tool manufacturers (Black & Decker)
and industrial suppliers (Illinois Tool Works)," USA Today
business writers George Hager and Dina Temple-Raston noted in a
December 20 story.
When the Fed last acted on May 16, the NASDAQ closed at 3717.57.
On December 20, the NASDAQ finally landed at 2332.78, a drop of 37
percent. The devaluation of NASDAQ stocks doesnít just hurt
investorsí portfolios and retirement funds; the crash also indicates
a sudden scarcity in the capital funds needed for research and
expansion, a money crunch that could affect the economy for years.
Was all of this foreseeable last May? It was to Larry Kudlow, a
free market economist who worked in Ronald Reaganís administration.
Back in May, Kudlow wrote in an op-ed published in the Washington
Times that "with price reports holding steady in April, a Fed
move to aggressively raise the overnight policy rate by 50 basis
points can signal only one objective: a determined effort to depress
Explaining the Fedís logic, Kudlow related that "The Fed... is
wedded to the Phillips Curve, a theory asserting that declining
unemployment generates rising inflation. This model has completely
broken down in recent years (for the umpteenth time since World War
II), as a combination of productivity-enhancing technology
breakthroughs, a lower capital-gains tax rate (promoting record
venture capital investment) and low inflation (to hold down
long-term interest rates), has expanded the economyís long-term
potential to grow."
Correctly anticipating that the Fed wouldnít take his advice to
leave interest rates alone, Kudlow predicted that "if the Fed sticks
to the Phillips Curve and insists on aggressive moves to dampen
growth, production, and employment, then future trouble is in the
cards. Wrong models generate bad results, no matter how good policy
intentions may be."
But network correspondents, who are often eager to criticize the
actions of Presidents, Senators, Congressmen and (U.S.) Supreme
Court Justices, mainly restricted themselves to explaining the
perceived consequences of the rate hike, although CBSís Anthony
Mason quoted an economist who agreed with the Fedís action: "As the
water has moved from tepid to warm, nobodyís being burned by this
inflation yet. But by the time we are burned, itís too late."
The closest any of the broadcast networks came back in May to
acknowledging Kudlowís views was in an epilogue to Masonís story.
"You may want to note that some economists disagree about the need
for raising interest rates, arguing that it risks hurting a very
healthy economy," anchor Dan Rather intoned, gratuitously adding
that "the record U.S. economic expansion is now in its 110th month.
And in a CBS News/New York Times poll, most Americans ó 87
percent ó say the Clinton administration deserves some of the
The key dispute is between economists who believe, as a majority
of Federal Reserve Governors apparently believe, that the government
should restrain economic growth to prevent inflation, and those who
want as few restraints as possible on private economic activity.
Thatís one reason why itís important to watch President-elect George
W. Bush, whoíll have the chance to name three new members to the Fed
board when he assumes the presidency next month.
Kudlow now says that "the Federal Reserve made another
boneheaded decision by failing to cut the key federal funds rate and
end the liquidity deflation that is damaging stock markets and the
economy," and he thinks Greenspan should use his authority to cut
rates before the next FOMC meeting on January 31.
Last spring, the broadcast networks didnít do a very good job
explaining to viewers the objections that free market experts such
as Kudlow had with the assumptions behind the Fedís interest rate
maneuvers. It turned out, however, that Kudlow was right and those
who were patting Greenspan on the back were wrong. In the coming
year, the networks can provide their viewers with better economic
analysis by including economists with free market views in their
Rolodex of experts.