Recession or Inflation? One Economist Fears Both

Most people know th a t the Feder a l Reserve System h a s some power to a ffect interest r a tes a nd other m a rket conditions in its effort to m a int a in a he a lthy economy a s it steers between the Scyll a a nd Ch a rybdis of recession a nd infl a tion.

But the ins a nd outs of the Fed’s monet a ry policy m a y b a ffle ne a rly everyone except the economists.

Robert T. P a rry, president of the Feder a l Reserve B a nk of S a n Fr a ncisco and an economist, knows the formul a s, the models a nd a ll the f a ctors th a t go into a n underst a nding of how the economy works a nd how monet a ry policy c a n a ffect it.

A s he a d of one of the 12 reserve b a nks in the system, P a rry is a member of the Fed’s key committee, the Feder a l Open M a rket Committee. This committee, which a lso includes the seven Feder a l Reserve Bo a rd governors, sets short-term monet a ry policy for the Fed by deciding on such m a tters a s whether to tighten the money supply.

P a rry, 48, a Phi Bet a K a pp a gr a du a te of Gettysburg College in Pennsylv a ni a , holds m a ster’s a nd doctor a te degrees in economics from the University of Pennsylv a ni a . He w a s a st a ff rese a rch economist for the Fed in W a shington from 1965 to 1970, when he left to become chief economist for Security P a cific N a tion a l B a nk. He left Security P a cific two ye a rs a go to t a ke the top post a t the S a n Fr a ncisco b a nk.

Parry recently spoke at a Town Hall of California meeting in Irvine--his first public speech this year in Southern California--to share his views on the economy and on the threat of inflation .

In an interview with staff writer James S. Granelli, Parry discussed his concerns about recession and inflation and his thoughts about how California, and Southern California in particular , would weather the possible storms.

Q: In recent speeches you indicate concern about two very different directions the economy may take--recession and inflation. Can you explain?

A. Well, I think that you have to put time frames on those concerns. In the short run, it seems to me the greatest uncertainties are associated with the strength of the economy. We saw some very recent numbers that indicated that though output expanded very rapidly in the fourth quarter, there was a decided slowing in demand. Consumers were not spending as much, and, as a result, we now have a very sharp growth of inventories. This could lead to reductions in production in the next couple of months and weakness in the economy during the first part of the year. So short term, I’d say my primary concern is probably a concern about the possibility of significant weakness in the economy.

Q. And in the longer term?

A. Longer term--and I think it’s important to give perspective on these issues--I still believe that our primary challenge is going to be inflation. And I believe that because some of those factors that lead to inflation are still present in our economy.

Q. What are those factors?

A. The immediate ones are an economy that is running in the range of full employment with strong growth prospects beyond the near term. Also continued increases in import prices, resulting from a three-year decline in the dollar, feed through to the domestic economy and add to price and wage gains and, ultimately, inflation.

Q. Do you believe that you may be prematurely alarming the public about inflation?

A. I’m sure there will be those who would say that. I don’t think that’s correct. I’d say that rather than viewing it that way, I think I’m trying to provide a perspective to the issue. One reads, particularly in recent weeks, discussions that just focus on the weakness of the economy. There was even a quote in a major newspaper today of a prominent economist who said that the inflation issue is dead, or not alive. I don’t think that’s a good perspective. I think we have to give a balanced perspective, and that’s how I see that balanced perspective turning out.

Q. California, and Orange County in particular, has weathered previous recessions fairly well. In light of the stock market crash and the concern over a possible recession, do you think the state and Southern California can expect to maintain that sort of edge in the near future if the recession occurs?

A. Well, if we had a significant slowing in the economy, and particularly if it qualified as a recession, I’m sure you would see the impact in California. California is now such a large part of the rest of the nation that it’s very difficult to see the situation where you would go through a major adjustment in the national economy without any impact on California. Having said that, I think it’s still true that California has some advantages that are likely to make any slowdown in economic activity nationwide perhaps less pronounced in California. And I might say that I’d even emphasize that more when it comes to the Los Angeles-Orange County area.

Q. Why is that?

A. If you look at the growth of employment and the growth of the economy in these areas over the longer term, they’ve been much stronger than the nation and quite a bit stronger than California. And I think there is an underlying strength in this area that is likely to provide some fairly significant insulation to a nationwide slowdown in the economy.

Q. Would you expect the current economic trends in Southern California to continue?

A. The basic trends, I think, will--and that is that you have a rapidly growing, dynamic, highly diversified economy. I think that basic trend is going to continue. Longer term, I’m sure there will be challenges that are going to face the area that have to be dealt with. I think that congestion is clearly one, and transportation is another. I know that everyone I speak with living in the Orange County area feels as though transportation has become a very serious problem. I think affordable housing is a very big problem for the area because a lot of people who work in the area have to live out as far as Riverside or Ventura. That’s difficult for an area. So I think there are some very substantial environment problems--business environment problems--that the area has to deal with. Again, if you provide a balance to the issue, there are so many pluses going for the area that I think it’s going to weather these storms rather well.

Q. If inflation does come, how would that affect some of these very things--employment, affordable housing and so forth--that you mentioned?

A. I think we have a lot to lose from inflation. I think that inflation is hard on wage earners, particularly if their wages don’t rise as rapidly. I think one of the sources of inflation, at least initially, would be in terms of higher prices of imported products. And that means that people’s purchasing power, their ability to buy goods, will be reduced.

Q. How would the Fed react?

A. I think that monetary policy would probably move in a direction to try to eliminate inflation or reduce it. Let’s say we saw inflation beginning to accelerate, moving up above 4% and 5%. I think that what would happen is that you would probably see efforts to slow down inflation. And if we do that, if monetary and fiscal policy are directed toward slowing inflation, it also means that economic activity doesn’t grow rapidly. Perhaps employment will no longer grow and unemployment will rise. So I think, if we were to go back into one of these highly inflationary environments, we all have a lot to lose.

Q. How would California fare compared to the rest of the nation in a highly inflationary period?

A. I really don’t know. I think that one thing I have observed is that California very often has a somewhat higher inflation rate than the rest of the nation. So the one observation I can make is that it’s conceivable that if we did go through a period of accelerating inflation, it may be that the inflation might be greater in this area. If you go back to the 1970s and remember what happened to the price of housing, prices here rose so much more rapidly, and a lot of that was related to what happened to housing prices.

Q. When do you expect inflation to surface to such an extent that it would once again be a prime concern for the Fed? June? July? August?

A. I’ll be honest with you: Trying to be specific about when these concerns might show up is very difficult. I think the concern about the strength of the economy is a present concern. It’s immediate. I think the other one we have to really see. All I’m saying is that some time down the road, and I don’t know exactly when that is, inflation is going to be a serious concern for us.

Q. But inflation will be a concern in the near future, not five years from now.

A. Right.

Q. How can the Fed keep inflation down?

A. Well, I think we have to have policies that are directed toward moving the inflation rate down closer to zero. But it’s complex in the sense that you can’t pursue those policies undaunted at every point in time. And this is a great example of that. At the present time, I think our focus is on the strength of the economy. And maybe our vigilance and our concern about inflation at this point in time ought to be pushed to the side a bit. It’s almost like an art. I think that at some point, one is going to become more confident that the economy is on the right track, that economic growth is proceeding at a pace which is hopefully acceptable, and you can then concern yourself more about inflationary concerns. Mechanically, we would try to keep inflation down by slowing the monetary aggregates--M-2 and M-3--that include most of consumer and business deposits at banks and thrifts and money-market funds. This might require for at least a period of time some rise in interest rates. But as inflation falls below the 3% to 4% range, we would expect interest rates to lower.

Q. You have said in your speeches that Southern California would be hurt by protectionist laws. Why would it be hurt more than other areas of the country?

A. Well, don’t get me wrong, I think the entire country would be hurt, but I think that California has a lot at stake because one of its very significant industries is international trade. Now I had an opportunity a while ago to tour the Port of Long Beach. The Port of Long Beach and the Los Angeles port are growing very rapidly. These ports are providing lots of jobs for people directly and indirectly. Now one thing that’s interesting is their trade balance is in favor of imports. A lot more is imported into this area than is exported through these ports. If you have protectionism, what’s that designed to do? Cut down on imports. Now how can you cut down on imports without the port suffering?

Q. So what position should the state take on protectionist legislation?

A. I’d say that California ought to be an area that is very strongly in favor of free trade. And it’s not only because we import a lot, it’s because we also export a lot. Look at our agriculture for where we see exports. Look at our high-tech exports. So I think if I were to make a list of concerns--particularly concerns for the California, Los Angeles, Orange County economies--one of the top concerns I’d have is this protectionism.