excellent piece
online.wsj.com
Greenspan Underestimated Bubble
And Now Overestimates Expansion
August 11, 2004; Page C1
For two years, Alan Greenspan has stood on the deck of the American economy under a banner reading "Mission Accomplished."
In that time, the Fed chairman has been eager to take credit for stewarding the economy through a financial bubble and its turbulent aftermath. Two years ago, in Jackson Hole, Wyo., he said it was "reasonable" to assert that "no low-risk, low-cost, incremental monetary tightening exists that can reliably deflate a bubble."
Perhaps. But, controversially, he went further, arguing that it appears there isn't even a Federal Reserve policy that "can at least limit the size of a bubble and, hence, its destructive fallout."
Cut to last month, when he testified before Congress with a full-throated endorsement of the strength of the economy. Even as oil prices pressed higher, employment flagged and consumer spending trickled down, Sir Alan dismissed concerns, saying that the economy has hit merely a "soft patch" that would be "short-lived," and that the current condition "bodes well for consumer spending."
Mr. Greenspan and the Fed have boxed themselves in. After a few strong payroll reports and some inflation numbers that topped expectations earlier this year, the Fed's pledge of "patience" and ability to wait a "considerable period" went out the window.
The Fed then went on its current measured course to raise rates to maintain price stability and seemingly won't be deterred, even in the face of a sputtering economy.
Therefore, the sluggishness must be defined as temporary.
So the federal-funds rate went up a quarter of a point to 1.5% yesterday, with little substantive change in the Fed policy makers' description of the outlook.
They are raising rates into a slowing economy because they have said they were going to. To not have raised interest rates yesterday risked seriously wrong-footing the markets and eroding credibility.
[Chart]
But the Fed and its chairman aren't just in that one box.
They are in the middle of a Russian doll of their own making.
Mr. Greenspan must now raise rates, because, for Mr. Greenspan's legacy, the economy must be on a steady expansion path. It must be so because he has asserted that he dealt with the bubble and its aftermath correctly. For that amount and duration of stimulus -- coupled with the enormous tax cuts from the Bush administration -- not to revive the economy would mean that the Fed's "Deal With Bubbles After They Pop" policy isn't a successful course.
Goldman Sachs economist Bill Dudley thinks the Fed has "fundamentally underweighted the importance of the bursting of the bubble."
It is difficult for Mr. Greenspan to say the bubble is the reason for the current lackluster conditions "because then they have to say the bubble had real consequences, not just financial consequences. It forces them to take responsibility."
Mr. Greenspan could have mitigated this problem by not declaring victory prematurely.
He could have been more cautious about the sustainability of this fragile economic expansion. The Fed needs to keep an eye on inflation, but it needs to do less jawboning and more plain speaking.
The Federal Open Market Committee shouldn't have been cheerleading for the economy in its statement yesterday, and it probably should have waited out this soft patch before raising rates again.
Mr. Greenspan might take satisfaction that he is now being criticized by some economists and Wall Streeters for raising interest rates, when only a couple of months ago, he was being lambasted by other investors for being hopelessly behind the inflation curve.
But just because different factions have equal and opposite critiques of your tenure doesn't mean you are doing a good job.
It is true that corporations are in shipshape, with strong balance sheets and high margins. The tide of the global economy is rising.
If Mr. Greenspan turns out to be right and the economy starts to pick up steam again, he will -- again -- look brilliant.
If not, start bailing. |
