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Fed's Role in Recovery

`TENNESSEE ERNIE" FORD used to sing about "gettin' another day older and deeper in debt."

That's apparently what Americans were doing this past Christmas season. Credit-card use rose 20 percent in December. Retail sales were the best in five years.

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Some economists worry whether that pace will continue this year. They note that job creation is stagnant with significant layoffs still under way, and that personal income growth remains weak. "Where will consumers find the money to pay off these new debts?" they ask.

Other economists respond that perhaps the burst in spending will induce businesses to expand their payrolls to produce the extra goods being bought, and those newly hired employees will start spending also. Households have been trimming their debts for a few years. Probably they can add to their debts again.

The Federal Reserve seems to be counting on this latter scenario for a more robust recovery.

Fed officials got some encouragement from a sizeable uptick in December's index of leading indicators and from a 3.8 percent annual growth rate in national output during the fourth quarter of last year.

That growth rate is modest compared with previous postwar recoveries. However, if the fourth-quarter rate continues, it might calm the Democrat-controlled Congress. Right now, some powerful lawmakers are concerned that the Fed, in its determination to stop inflation, might put the economy through another period of slow growth that would do little to reduce unemployment or the federal deficit. These lawmakers worry that the broad measures of money are growing too slowly.

Indeed, for part of last month and December, the money supply - the fuel for economic activity - was shrinking again. The money measure known as M-1 has grown at a handsome 15.8 percent annual rate in the past three months. M-1 includes currency, demand deposits, and other checkable deposits. M-2 has been growing at only a 2.8 percent rate in the same period. M-2 includes M-1 plus some savings.

Of course, factors other than the money supply affect the business cycle.

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Still, the Fed is taking a big gamble when it allows money growth to slow down at this stage of the recovery. Fed chairman Alan Greenspan explained at congressional hearings last week why M-2 growth is well below the Fed's own target range.

Economic forecasting is an imprecise science. But if the Fed is wrong and the economy pauses again, it will get into political hot water. We think the better course is another interest-rate reduction.

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