Get smart about inflation.

• Author: Georges, Christopher
• Position: Interest rates and the economy

For a moment this spring, madness was rampant. Whitewater crowded health care and education off the front pages; Barry Goldwater told the Republicans to get off Clinton's back; John Bobbitt announced he's marrying again. Most important, the Federal Reserve and Wall Street went bananas as rising interest rates sent the stock and bond markets on a roller coaster ride."Dow Falls 72 Points Amid Market Fears" screamed a March 30 headline in the Los Angeles Times. The subhead? "Seventh drop in eight days puts average 300 below where it stood two weeks ago. Investors are worried by interest rates and political turmoil."

This market madness is especially perplexing given the economic facts. Last winter, the economy finally hit its stride: Unemployment dropped; consumer confidence rose. Sales of automobiles, furniture, and other durable goods rose 15.4 percent, and new home sales jumped 31 percent. In fact, the economy overall grew at an amazing 7.5 percentage points in the last quarter of 1993, its strongest showing in over a decade. But in every silver cloud there is a dark lining. Consider this from The Washington Post's front page report on the growth figures: "[The 7.5 percent increase] cheered White House officials and economists but triggered a sell-off by Wall Street traders fearful that inflation is not far behind.... what they saw yesterday was more inflation, higher interest rates, and the end to the bull markets of the early 1990s."

What gives? Why, if things were going so well, did the financial markets immediately assume prosperity meant inflation? An assumption that we must break down--this is the reform--is that economic upswings are automatically followed by inflation unless the Fed raises interest rates to slow growth. If the country is to generate true, long-term growth, we must stop saying this, in the face of contradictory evidence, because the more we say it, the greater the chances the Fed and the markets will turn it into a self-fulfilling prophecy.

According to conventional wisdom, as the economy grows, people buy more goods. But when people buy more, we must produce more to fill their needs. Suddenly, there are production bottlenecks and labor shortages. This causes prices to rise. Wages then rise to keep pace with prices. The result: inflation. This view is so ingrained that few even question it; it is a staple of economic journalism, presented without question or nuance. On "Good Morning America" during the stock market's...