FEAR OF INFLATION IS STIFLING THE NATION

By FELIX G. ROHATYN

As recently as March, most observers were concerned that the economy might be headed for recession. Many expected the Federal Reserve to lower interest rates. Suddenly the great concern is that the economy may be growing too fast. Earlier this month, the Commerce Department reported that the economy grew at a rate of 2.8% during the first quarter of the year. The bond and stock markets treated this very good news as if it were an unwelcome visitor, and declined sharply. Fickle behavior in financial markets is nothing new, but this latest episode illustrates a deeper problem.

It has become an article of faith among policymakers and on Wall Street that if the economy grows at an annual rate above 2% or 2 1/2%, inflation will rise, perhaps uncontrollably. As illustrated by recent events, such conventional wisdom has become almost a self-fulfilling limitation. When growth rises above this level, investors, spooked by a belief that the Federal Reserve will soon be "forced" to raise short-term interest rates in order to prevent an outbreak of inflation, rush to sell bonds. This pushes long-term interest rates up. The result is that prospects for future growth are dampened. (And should the Fed do nothing, bondholders sell because they fear the central bank is no longer vigilant against inflation.)

The irony is that these economic statistics, which so frightened the markets, actually tell us that higher growth is possible without inflation. The real rate of inflation for the first quarter was 2.1%, with no sign of any upward pressure; actual growth was understated because of the General Motors strike and the winter blizzard. And remember, inflation statistics are generally believed to be overstated at least 0.5%.

What the first-quarter results make clearer is that the economy can grow more than 3% while holding real inflation below 2%. The same can be said about unemployment. The latest unemployment figures came in at 5.4%; that's well below the 6% unemployment figure that is supposed to trigger inflation through demands for higher wages, according to the standard view. This view fails to take into account the forces of global competition. American workers no longer compete for jobs only with one another, but with workers worldwide, and that tends to dampen wage demands at home. Wage inflation is not a real threat, but we keep treating it as such.

Sure, one quarter isn't a trend, but there is nothing in these numbers to provoke fear of inflation; on the contrary, they should have been the basis for satisfaction and the determination to do better. The conventional wisdom, however, is so embedded in the financial community that the National Economic Council chairman, Laura D'Andrea Tyson, felt understandably compelled to reassure the markets by announcing that the Administration's growth forecast for the year was unchanged from its original 2.2%. It should not be necessary to tell Wall Street that the economy isn't as good as it looks.

There was a time when 2.8% would have been considered a modest rate of growth; today it is considered dangerously robust. The sad reality is that it is still below our real needs. Many corporate leaders don't agree with this notion of dragging the anchor just as soon as the economy has the wind behind it. They understand how we can sustain high growth based on the muscular productivity improvements they are generating in their own businesses. In today's environment of rapid technological innovation and international integration, we should be willing to be bolder, both in fiscal and monetary policy.

Our excessive fear of inflation has a huge price: stagnating wages for the vast majority of American workers, the decline of our cities and the deepening of our social and economic ills. Although there is no single answer to these problems, increasing wealth and incomes hardly seems like a bad way to start. As President Kennedy said, "A rising tide lifts all boats." The difference between then and now is that the tide is not rising as fast--and it certainly is not raising all boats equally. Without more growth we are simply setting the stage for a battle over the same pie.

We need higher growth if we are to balance the budget without unacceptable cuts to social programs, or without letting our infrastructure crumble. Only a growing economy lets us generate the revenues needed by the public sector while reducing the tax burden on the private sector.

The Clinton Administration is entitled to a great deal of credit for cutting the federal deficit in half, while putting the economy on a path of stable, moderate growth. But it's time for Administration and congressional leaders to take advantage of the current momentum to reach for a higher level. It's also time for Wall Street and the Federal Reserve to stop kicking up interest rates reflexively every time the economy shows signs of momentum. The notion that we must choose between growth and inflation is a false choice. Global competition as well as new technologies has set new parameters on every aspect of the economy. A 3%-to-3 1/2% growth rate is not only an achievable national objective; it is an economic and social necessity.