Greenspan's final days

Posted: May 09, 2005 12:00 AM

WASHINGTON, D.C. -- Alan Greenspan, in the last year of his long tenure as chairman of the Federal Reserve Board, is described by close onlookers as confused by the economic data. He confronts this question in his final months as America's central banker: Can he avoid the legacy of either a "Greenspan inflation" or a "Greenspan recession"?
 Contrary to the conventional wisdom, recession might be the more realistic danger. The army of number-crunchers at the Fed does not give Greenspan the statistical security blanket he craves. The Consumer Price Index's warning of inflation ahead is regarded by one Federal Reserve governor as "phony." Nevertheless, inflation concerns were rising at the Fed until weaker economic news prevailed going into last Tuesday's meeting of the Federal Open Market Committee (FOMC). Then, three days later, gains in employment reported on Friday suggested greater inflationary danger.

 So, what's a central banker to do? The Greenspan-led Fed ploughs ahead with an inflexible determination to increase the inter-bank interest rate by one-quarter of one percent every time the FOMC meets, no matter what the economy looks like. It did so Tuesday for the eighth consecutive meeting, and there is no end in sight.

 The problem is that, historically, central banks go too far in tightening money, to overshoot their anti-inflation goals. Greenspan famously overshot when the federal funds rate reached 6.5 percent in May 2000, ushering in recession to start George W. Bush's presidency. That ended a doubling of the rate. With last week's increase, Greenspan now has tripled the low of 1 percent. That raises the question of whether the Fed already has tightened enough.

 One sign that might well caution the Fed not to keep raising interest rates is they did not have the desired effect on long-term rates as an anti-inflationary mechanism. Instead of rising, long-term rates dropped a little last week. This phenomenon usually occurs at the end of a long period of tightening, indicating no more interest hikes are needed. But the Fed is not recognizing that signal.

 On the contrary, some members of the FOMC at their previous meeting on March 22 wanted to send a stronger anti-inflation message by dropping language saying that the Fed would continue to fight inflation at a "measured pace." If financiers had found the word "measured" missing, the impact on markets could have been devastating.

 This omission of "measured" would actually have seemed a flagrant misjudgment in view of the economy's apparent weakening after the March 22 meeting. Federal Reserve Governor Ben Bernanke stepped in during the closed-door meeting to say this was a very bad idea. The language was not changed.

 By the time the FOMC met on May 4, Bernanke was not present due to his appointment to the president's Council of Economic Advisers. No effort was made this time to remove "measured."

 Where was Greenspan, the most masterful Fed chairman in history? He seemed disengaged March 22 in the debate over "measured," according to Fed sources. One especially adroit Fed-watcher described his performance that day as "coy."

 Greenspan was not coy last Tuesday when, in an apparent accident, the Fed's public statement omitted a sentence saying that "longer-term inflation expectations remain well contained." Before much damage could be done, the omission of "contained" was described as an oversight and Greenspan restored the word. The chairman wants no changes.

 Indeed, Greenspan does not want to make waves as his long, celebrated tenure comes to an end. If he leaves on schedule next January, he will fall a few months short of the record long chairmanship by William McChesney Martin ending in 1970 after 18 years, nine months. Greenspan would like to beat that record, and he may have a chance, considering the slow pace at which replacements are made in the U.S. government.

 All signs are he just wants to get out without a "Greenspan recession" or a "Greenspan inflation." Another two months will elapse before the next FOMC meetings, providing time to sort things out. Greenspan surely is not interested this late in his tenure in instituting more effective mechanisms to regularize the central bank's operations. Raising interest rates one quarter of one percent seems to be frozen as Fed policy, whatever its impact.