Lower Inflation and Recession Will Cut Interest Rates

INFLATION is winding down. The ``consumption deflator for goods'' - perhaps the best of government's many price indexes for measuring the cost of things people actually buy - rose at an annual rate of only 2.2 percent over the last three months. In retrospect, the 1990 ``oil shock'' had a smaller impact on reported rates of inflation than the cold snap in December 1989. Some asset prices - especially for real estate - have tumbled. Corporate profits have faded because business managers can't pass higher costs to final purchasers.

By contrast, financial markets have been acting as though the recession were over and inflation was coming back. Stock prices went up and interest rates rose. The reason was not hard to find. Wall Street spin doctors - who make their living whipsawing investors between euphoria and despair - went out of their way to hype every shard of positive economic information, no matter how tenuous. The exercise was profitable. Put options on the Treasury bond future more than doubled in value.

In reality, while the Gulf war is over, the recession continues. Real consumer purchases of goods - an excellent measure of things that people actually buy - declined at an annual rate of 19 percent in January. Such purchases have declined at a rate of more than 8 percent since the recession began last July.

The bad news about consumer spending suggested that good news about inflation is likely. When the pattern of slower inflation becomes clearer to market players, interest rates should drop further.

If this forecast proves correct, home buyers should move quickly to take advantage of lower rates. Falling rates and rising bond prices are not likely to last long. Bond traders must be nimble to enjoy this rally.

Meanwhile, the Commerce Department's index of coincident economic indicators - a gauge that mimics the contemporary behavior of gross national product - crashed this winter. This index was down at an annual rate of more than 17 percent in January. So far during the current recession, it has slumped at a rate of 10 percent.

People are out of work. Almost 3.2 million workers were receiving unemployment insurance in mid-February, up at a 59 percent rate from last summer.

Because of the steep decline in employment (1.3 million people have lost their jobs), real personal income (including government handouts, interest, and dividends) declined at an annual rate of 12.3 percent in January. Real disposable income, which measures after-tax purchasing power in constant 1982 dollars, has not changed since February of 1989.

The real money supply declined in January for the sixth month in a row. Real money - currency, checking accounts, and consumer thrift accounts measured in constant dollars - rose in February. However, there is a six to nine month lag from the time the Fed begins to add to the money supply until the economy starts to respond.

Even though chances for intermediate-term price stability have improved, this begs the critical question about monetary policy: Can the Federal Reserve consolidate its gains in the battle against inflation? Preliminary indications are not encouraging.

Members of Congress give price stability a low priority. Rep. Stephen Neal (D) of North Carolina, who chairs the House Subcommittee on Domestic Monetary Policy, is pushing a resolution to make zero inflation the Fed's primary target. At a recent conference, a member of the audience asked Representative Neal how many votes he had. ``About 10,'' he answered.

The White House pays aggressive lip service to the principle of stable prices. However, the Bush administration has refused to support Neal's zero inflation resolution. Indeed, the President's Council of Economic Advisers said last month that ``monetary policy ... has helped keep the underlying rate of inflation relatively low and relatively steady ... The credibility that this experience has built, combined with the recent relatively low inflation rates, gives the Federal Reserve more elbow room to all ow inflation to rise temporarily.''

The White House, like Saddam Hussein, apparently intends to declare victory over inflation and then surrender.