The federal reserve raised short-term interest rates again last week, increasing the “Fed Funds” rate to 6 percent. The Fed has increased the rate seven times, a full 3 percentage points, in the past year to slow the economy and prevent higher inflation. Is the latest increase overkill? Stalking phantom inflation, will the Fed trigger a slump? The answer is that no one can tell. There’s no exact science to say when rates should and shouldn’t be increased.

After several decades of economics reporting (reminder: I am no economist), I have concluded that economists know a lot less than they think they do. Why? Well, what we call “the economy” is merely the collective outcome of millions of daily spending, saving and investment decisions, which constantly shift under the influence of new ideas, institutions and social conditions. The process has not – and never will be – frozen in time, and so economists’ attempts to visualize how it operates are inevitably incomplete and out of date.

They can make estimates based on good but flawed statistics. They can detect general tendencies. But that’s about it. In a recent essay entitled “The End of Economics as We Know It,” economist Herbert Stein of the American Enterprise Institute reached a similar conclusion.[*] Economists, he wrote, have exhibited the “greatest self-confidence” in history. But that confidence was misplaced, because they can’t fully solve the two main economic problems of our time: ending business cycles, and raising the long-term rate of economic growth.

Just a year ago, top Fed officials (most of them economists) forecast the economy for 1994. On average, they predicted economic growth of 3 to 3.25 percent, inflation of about 3 percent and year-end unemployment between 6.5 and 6.75 percent. In fact, the economy grew 4 percent, inflation was only 2.7 percent and unemployment dropped to 5.6 percent. Economic and job growth were underpredicted, while inflation was overpredicted.

It is not that the people at the Fed are dolts or that, therefore, raising interest rates is an obvious blunder. Personally, I support it; inflation ought to be suppressed before it visibly increases. The point is that this is a judgment call, because information is imperfect and people are fallible. To control business cycles – to prevent slumps and inflation – the Fed would have to predict the economy perfectly, so it would know when to change policies. Then, it would have to know exactly how fast to let the economy grow. And finally, it would need the tools to make the economy abide by its wishes.

The Fed falls short on all counts. As we’ve seen, its predictive powers are poor. It is even less certain of the economy’s growth potential. To gauge that, it needs to know the “natural rate” of unemployment-the lowest rate that won’t trigger inflationary wage increases – and the rate of potential economic growth once “unnatural” unemployment is exhausted. Unfortunately, both concepts are wispy guesses. Until recently, conventional wisdom put the “natural rate of unemployment” at about 6 percent; now some economists think it could be 5.5 percent or lower.

As for potential economic growth, the standard estimate is now 2.5 percent a year, consisting of about 1 percent annual growth in the number of workers and 1.5 percent annual gains in productivity (output per worker). But productivity growth might be higher or lower, because it depends on so many factors, from technology to business practices. Finally, even if the Fed knew all these things, it couldn’t control business cycles. The Fed regulates only short-term interest rates, and these rates are just one influence on how people and companies spend.

In short, what seems simple in concept – that the Fed should keep the economy gliding along a path of noninflationary growth – is almost impossible in practice. The Fed’s powers are crude, because their effects commingle with the economy’s own spontaneous changes. Perhaps the Fed will succeed and sustain the economic expansion a few more years without higher inflation; or perhaps the Fed won’t. What is certain is that mistakes will be made in the future just as in the past.

The larger lesson is that economic wisdom has not yet progressed to the point where desirable changes can be ordered a la carte. The trouble is that many Americans think otherwise, and when the economy misperforms, they feel misused by incompetent leaders. Economists of all parties have fostered popular delusion by overstating the power of their ideas. Those who don’t make themselves politically irrelevant, because politicians favor advisers with neat answers to pressing problems.

A case in point is the current debate over how government estimates the impact of tax cuts on revenues. Present practices (termed “static” estimates) assume that tax changes don’t quickly change long-term economic growth; by contrast, some economists urge “dynamic” estimates that assume lower taxes raise economic growth and tax collections. How convenient. It’s a debating point for tax cuts. The trouble is the whole exercise is dishonest; economists don’t know enough to predict how a tax cut of, say, $35 billion will alter long-term growth in a $7 trillion economy.

Economics can illuminate broad choices, but those choices may not always fit political needs. Some policies are better than others, but the consequences – for good or ill – often fall outside the current election cycle. To take the issues at hand: the country will be better off if inflation is kept in check even if that means periodic recessions; and, if people want tax cuts, they should first balance the budget and not rely on dubious “revenue estimates.” Economists would serve us better if we thought they could do less: In the end, the public is not fooled, only disillusioned.

  • “On the Other Hand . . . Essays on Economics, Economists, and Politics,” American Enterprise Institute. $25.95.