By suddenly raising its discount rate this week, the Federal Reserve Board reaffirmed its commitment to fighting inflation.
In the process, the FRB also wisely put long-term economics ahead of short-range politics. Consequently, the administration is over-reacting when it objects to this move.The discount rate - the fee the FRB charges on loans to financial institutions - affects other forms of credit, such as mortgages, consumer loans, and the prime rate that banks charge their best customers. At some point, higher interest rates slow economic growth by deterring purchases.
Hence the complaints from the White House and Vice President Bush, who find it easy to imagine disgruntled consumers taking out their resentments against the FRB by going to the polls next November and voting against the party in power.
But it's hard to imagine the public's being happy if the Federal Reserve Board sat on its hands while inflation kept inching upward. By acting vigorously to curb the price spiral, the Fed can be thought of as reinforcing the administration's claims to have conquered inflation.
Politics aside, the fact is that the Fed's action was not only warranted - it was overdue.
Only a few days ago, the Labor Department reported that hourly earnings in July rose at the annual rate of 6 percent, raising fears of wage inflation. Unemployment remains near a 14-year low. The economy is growing by a strong 3.5 percent to 4 percent. Industry is working close to capacity.
All these factors work to push prices higher. So does the drought.
The Fed's action, of course, is not without certain painful side-effects. Higher interest rates help attract foreign investment, which the U.S. needs because Americans don't save as much as foreigners often do. This increased foreign investment, in turn, pushes up the dollar on currency exchanges. And a dearer dollar threatens to stop the recent shrinking of the foreign trade deficit.
Moreover, by raising the discount rate from 6 percent up to 6.5 percent, its highest level in more than two years, the Fed upset nervous markets - sending bond prices and stocks sharply lower.
In the long run, however, higher interest rates can work to stabilize stock and bond prices by calming inflation worries. In the short run, savers should get a break as a result of the hike in the discount rate; bank certificates of deposit and various certificates with variable rates are likely to bring better yields in the next few weeks.
On balance, the Federal Reserve Board clearly did the right thing and ought not to be used as a punching bag for short-sighted or partisan purposes.