Did Greenspan Ignore Recession Warning?
MoneyNews
Wednesday, April 7, 2006
1. Did Greenspan Ignore Recession Warning?
At a 2000 Federal Reserve interest-rate meeting, the agency's chief forecaster Michael Prell warned that a potential economic collapse was on the horizon - but his prediction fell upon deaf ears.
It turned out to be Prell's last meeting at the Fed - and then-Fed Chairman Alan Greenspan seemingly ignored his observations and went on to raise rates.
Prell's warning was revealed Wednesday, as the Fed released transcripts of the session from May of that year. While a policy statement is offered immediately after each Fed meeting, actual transcripts of the minutes are published on a five-year lag.
"What lies ahead is certainly less attractive than the landscape of the past few years," Prell, former head of the Fed's research and statistics division, said, according to transcripts. He referred to an economic "deluge" resulting from the bursting of a stock-market bubble.
After three straight years of more than 4% growth, officials at the time were desperate to slow the economy without causing unemployment or damaging the stock market.
"Later figures would show the economy grew at a 6.4% annual rate in the second quarter of 2000, prompting Greenspan and the Fed's rate committee to press for ways to control inflation," according to Bloomberg.
Contradicting Prell's analysis, Greenspan implemented a half-point rate hike - the Fed's sixth in its past eight meetings - bringing the benchmark up to 6.5%.
Of course, by the beginning of 2001, the U.S. was in the grips of recession, as the Nasdaq had plummeted by 64% and the S&P 500 had dropped 25%. That prompted the Fed to set in motion a massive slashing of rates in January 2001.
"The committee held a teleconference to approve a half-point cut, the start of a 5 1/2-percentage point reduction in the fed funds rate over 2 1/2 years," Bloomberg reports.
"The move's timing surprised almost anyone who wasn't at the Dec. 19 rate meeting, where Greenspan said the Fed, if necessary, would make such a cut in the first two weeks of January."
According to the transcripts, two Fed presidents at the meeting suggested the adoption of a strategy known as the numerical inflation objective. Essentially, that means that if a central bank or government says that inflation should be within a range of between 1.5% and 2.5%, it will actively seek to set monetary policy to achieve that rate.
But Greenspan shot that down - because he didn't feel there was enough evidence to prove to Congress that such a strategy would be effective.
Says Bloomberg: " 'If we get into a period where inflation rates start to differ among countries,' and those with inflation targets have more stable prices, 'I think we will grab on to inflation targeting as an obvious solution,' Greenspan said. 'It is very difficult at this stage to make that case up on the Hill.' "
Of course, we all remember what happened to the economy next.
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