That kind of plays with this article from today's NYT
>>January 10, 1999
ECONOMIC VIEW
For the Fed, a Sideshow Takes Center Ring
By LOUIS UCHITELLE
he Federal Reserve, as Alan Greenspan so often says, deals in the real
economy, not sideshows. Inflation, output, profits, employment, exports,
productivity -- these are all aspects of the real economy.
The stock market, in the Fed's scheme of things, is a sideshow. But the
sideshow has now decisively moved into the center ring, creating a
terrible dilemma for the Federal Reserve and the public, too.
The Fed normally regulates the real economy by adjusting interest rates,
lowering them to stimulate growth and raising them to remove this
stimulus. In normal times, stock prices then rise or fall in reflection
of the changing pace of the real economy, almost as if the market were a
meter. But over the last 12 weeks, and particularly the last four, the
stock market has shot up quite on its own. Instead of leading the
market, the real economy now follows it.
"There are many people who claim that we are in a new era of economic
performance, and the high stock market reflects this new reality," said
Henry Kaufman, a Wall Street economist. "There is some truth to that
claim. But when all is said and done, what we really have in the stock
market today is a speculative bubble."
The bubble creates the Fed's dilemma. In the past, Greenspan has
cautiously avoided sharp changes in interest rates, instead favoring
gradual moves to nudge the real economy without provoking an
overreaction in stock and bond markets.
But the bubble has become so sensitive that even a quarter-point move by
the Fed is potentially calamitous, threatening wild stock market swings
with the power to drag the economy along with them.
Say the Fed finds itself wanting to cut rates to offset some new danger
-- a Brazilian meltdown, for example, or the unanticipated bankruptcy of
some high-flying technology company. Wall Street would view the rate cut
as further evidence that, when adversity strikes, the Fed stands ready
to bail out the economy and the market. And stock prices would shoot up
again, just when they are already 30 percent overvalued, according to
several Wall Street estimates.
"Another rate cut would whip up the near-mania that already exists,"
said David M. Jones, chief economist at Aubrey G. Lanston & Co., a bond
firm.
Or say the Fed decides it must raise rates instead, to head off
inflation. It's not such a far-fetched idea: The economy grew in the
fourth quarter at a very robust annual rate of nearly 4 percent,
preliminary figures suggest, and the December job figures came in strong
on Friday.
Consumer spending played a big role in the healthy showing, and rising
stock prices fueled a big chunk of this spending. They also encouraged
business investment, another source of growth.
Boom times like these inevitably raise inflation concerns in the minds
of Fed policy makers, even though inflation is very low. But they pose
for the Fed the awful choice of leaving rates alone -- and encouraging
investors to go on thinking that the Fed cares more about sustaining
high stock prices than controlling inflation -- or raising rates to slow
the economy, with consequences that could be very unpleasant.
"Raising rates is out of the question," said Robert V. DiClemente, an
economist at Salomon Smith Barney. "It would burst the bubble."
A plunging stock market would then chill the economy much more than the
Fed intended. For example, a 30 percent decline in stock prices over 12
weeks could reduce economic growth by a painful 2.3 percentage points,
according to a computer model of the economy developed by Macroeconomic
Advisers Inc.
The Fed's top officials, including Greenspan, have said very little
lately about the stock market, although some hinted last week that they
consider stock prices higher today than the real economy can justify.
The Fed put itself in this tough spot unintentionally last fall, when
the Dow Jones industrial average was 26 percent lower than it is today,
and the Fed made three rate cuts of a quarter-point each.
The goal was to save the American economy and the world financial system
from the devastating blow of Russia's meltdown, the near bankruptcy of
Long-Term Capital Management and the abrupt refusal of frightened
investors to lend to the private sector.
The Fed policy makers recognized, according to the minutes of their Nov.
17 meeting, that their third rate cut, approved that day, "might trigger
a strong further advance in stock market prices that would not be
justified on the basis of likely future earnings and could therefore
lead to a relatively sharp and disruptive market adjustment later."
Rather prescient, so far. The world was saved, and stock prices did
shoot up, cornering the Fed and setting the stage for the next disaster
-- the disruptive market adjustment -- just when the American economy
seems to be moving along so well. << |
