A Nibble on the Golden Hook Jude Wanniski February 11, 1998

Memo To: Fed Chairman Alan Greenspan
From: Jude Wanniski
Re: Fed Gov. Edward Gramlich

In the February 4 Investor's Business Daily, reporter Sherry Kuczinski has an interview with your new colleague, Ed Gramlich, which you should see. Even though Gramlich was trained at Yale ~ the stomping grounds of Keynesian inflationist James Tobin — he admits to keeping an eye on gold. Yes, he has a lot of bad stuff in his head about how the unemployment rate is a good leading indicator of future inflation, but he confesses he is "puzzled" to see other signals pointing to lower inflation: "There are other indicators of future inflation, such as commodity prices and gold prices," he noted, "They still have a lot of informational value." Still, even though the gold price is in a lower range than it has been in for 20 years, Ms. Kuczinski says Gramlich "sees little risk... that the Fed will shoot past price stability into deflation." His evidence is that "Spreads between long-term and short-term interest rates say that the inflation threat now is pretty quiescent," but that he sees greater risks that inflation will pick up rather than fall farther.

Alan, you have here a potential ally. The fact that the former dean of Michigan's School of Public Policy admits to being "puzzled" about conflicting inflation signals is an opening for you. You either have to arm-wrestle him on his output-gap model, which seems to have taken over the Fed staff already, or allow your own views to be overwhelmed by it. You can clear up his puzzlement. You can tell him that the inflation information conveyed by the gold price is as good as it gets. When the gold price rises, it is telling Gramlich that in the future, the Consumer Price Index will eventually rise to catch up with gold. The CPI is a lagging indicator, as you know better than anyone, Alan. If you are going to combat inflation, you cannot wait for an inflation signal that shows up weeks or months or even years after the original inflationary impulse. Can't you explain this to Gramlich? If you are going to discourage your son from leading a life of crime, do you wait until he is accosted in a 7-11 store with a pistol in his hand? As long as Gramlich sees information value in gold — perhaps because of your private tutoring — you can steadily undermine his reliance on the Michigan "output-gap" model that predicts what is going on in the Fed's rear-view mirror.