THE FEDERAL RESERVE BOARD'S shift of strategy is dangerous but, unfortunately, justified. The Fed is in the position of a driver who has stepped on the brakes only to discover that the car seems to be speeding up. The Fed will now brake much harder, without knowing exactly how the vehicle will respond. Perhaps it will stop too suddenly for safety. The Fed has decided to take that risk. All it knows with certainty is that by far the greater risk is rising inflation.
Two weeks ago the Fed raised interest rates by a split vote that seemed to be leading to a long pause for internal debate and stock-taking. Instead, on Saturday, the board moved again, forcefully and unanimously. Several developments last week account for it. The producers' price index was published, adding to the evidence that -- contrary to the government's forecasts -- inflation was accelerating. The unemployment rate fell, strengthening the impression that the recession may unexpectedly have postponed itself. Meanwhile, at the Belgrade meeting of the International Monetary Fund, U.S. officials found themselves confronted with the full range of European anxieties over a sinking dollar.
The Fed had to act. But past experience is no longer a reliable guide to the economy's responses. An example: during the last great tightening of interest rates, from 1972 to 1974, housing starts dropped 40 percent. During the much steeper tightening that began in 1977, they have dropped very little. Why? Because most people now expect high inflation to continue indefinitely, and they consider investment in houses to provide protection from it. People are coping with inflation in ways that make inflation worse.
The government is now trying to damp down credit-fed speculation -- in real estate, gold, silver, antiques and all the rest -- without crippling the real economy that produces goods and creates jobs. To reduce the current surge of borrowing, the Fed did two things Saturday. It raised one key interest rate that will in turn raise others. It also changed the basic principle on which it steers monetary policy. It will no longer try to maintain target interest rates. Instead, it will rely more heavily on raising the reserves that banks are required to maintain. That's another way to try to hold down the growth of the money supply.
How well will it work in practice? That is a question for next year. The signals last week required action by the Fed. Higher rates are necessary, and the Fed has met its immediate responsibility. But it is important for Americans -- especially those in Congress -- to remember that tight money alone is not a balanced, effective program to reduce inflation.