Outlook: Inside Greenspan's head
"... so far we haven't seen any significant signs of the stock market's rise leading to excessive borrowing, which might cause additional concerns for the Fed."
ho ho ho
NEW YORK. 05:00 AM EDT—As the next Fed meeting approaches, Wall Street is getting jittery about the outlook for interest rates. Many leading economists and strategists now believe the Fed will raise interest rates by a quarter point on Aug. 24 to stave off inflationary pressures in the economy.
For some insight into what's going on at the Fed, we turned to a leading academic in the field, a Professor of Economics at Columbia University's business school.
Professor Mishkin should know his field well. He has been an academic consultant to the Board of Governors of the Federal Reserve System and a visiting scholar at the Ministry of Finance in Japan and the Reserve Bank of Australia. He is also an academic consultant to and on the Academic Advisory Panel of the Federal Reserve Bank of New York. From 1994 to 1997, he served as executive vice president and director of research at the Federal Reserve Bank of New York and was an associate economist of the Federal Open Market Committee of the Federal Reserve System.
Forbes.com: With the government busy cleaning up its debt, is monetary policy the only tool left to smooth out the business cycle?
In general, the idea of using fiscal policy to smooth out business cycles has lost much of its following in recent years. It turns out that fiscal policy isn't a very effective tool, because of the long lags between the policy changes and the actual impact on the economy. Economic research has found that even during the New Deal, monetary policy could have been used as a better tool for turning around the economy. Short-term interest rates dropped to almost zero at the time, but the Fed could have used other means to stimulate the economy, such as injecting liquidity.
On the other hand, the idea of using monetary policy to smooth out business cycles also has many detractors. Our experience from the 1970s showed us that it's impossible to implement an overly expansionary monetary policy without causing inflation. After the Vietnam War, the Federal Reserve tried to jumpstart the economy with an expansionary monetary policy. The result was an inflationary period that became destructive to economic growth.
Good monetary policy should be boring; it should be very clear what the goals of the Fed are and why.
Under Federal Reserve Chairman Alan Greenspan, the Fed has been focused on economic and financial stability rather than restraining growth. In what has been a very successful policy, the Fed has realized that its most important task is not to exacerbate business cycles, as indeed happened during the 1970s. At the same time, Greenspan has put emphasis on the importance of financial stability. That's why the Fed injected liquidity into the economy in the immediate aftermath of the 1987 stock market crash and lowered interest rates in the fall of 1998 amid concerns about the health of the financial system in the wake of the near collapse of the Long Term Capital Management hedge fund.
Forbes.com: On a scale from inflation hawk to inflation dove, how would you place Greenspan and the rest of the Fed's policy makers?
I don't like the term "inflation hawk" very much, because it implies that the Fed wants to curb growth as well as inflation. One of the reasons why Greenspan has been so successful is his singular focus on inflation. Greenspan has realized that it may be possible for the economy to grow relatively fast without inflationary pressures building up. It would be a mistake for the Fed to stick fanatically to a growth target of, say, 2% if the economy could indeed grow at a 3% rate without causing inflation.
At the same time, however, Greenspan's Fed is very aware of the dangers of inflation. I think right now the Fed's emphasis on inflation is stronger than it has been in the recent past. The Fed knows very well that it will have to strike preemptively to prevent inflationary pressures from building up.
Forbes.com: Greenspan is said to be particularly focused on labor costs. True?
I think Greenspan is worried about inflation, as indeed he should be, but not only wage inflation. Employment costs can very well rise without leading to inflation in, say, the consumer price index. If the cost of employing a worker rises at a slower pace than the rise in that worker's productivity, the Fed has no reason to worry.
Forbes.com: Greenspan has often cautioned that productivity growth can't continue forever. Why not? And when will it stop?
Actually, this is a misunderstanding. Productivity growth can continue in the future. But Greenspan has warned against "pie-in-the-sky" expectations for the acceleration in productivity growth.
We've seen an acceleration in productivity growth over the past few years. We're not sure exactly why productivity growth has accelerated, but it seems likely that the implementation of information technology is an important factor. It seems there's a lag between the availability of new technology and its impact on productivity. We saw such a lag with the invention of the electric generator and then later with the launch of the personal computer. We may see it again as people figure out how to use the Internet to advance productivity.
For some reason productivity growth was particularly strong in the 1960s and now again in the 1990s. We don't know exactly why productivity growth is stronger in some periods than in others. But I think good monetary policy should get some of the credit. When companies don't have to focus on how to hedge against inflation and interest rates, they can concentrate instead on cutting costs and increasing output.
Forbes.com: Greenspan has said several times that he doesn't want to use monetary policy to stimulate or depress the stock market. But with several economists talking about asset price inflation and the wealth effect, shouldn't he?
This is clearly an issue. High stock market gains could stimulate spending, which could be inflationary or could lead to increased borrowing by corporations.
I think Greenspan is right in focusing solely on the effect the stock market has on the economy as a whole. That would be consistent with the overall role of the Federal Reserve. And so far we haven't seen any significant signs of the stock market's rise leading to excessive borrowing, which might cause additional concerns for the Fed. |
