Barron's : Truth Serum for Greenspan.
February 19, 2001
Economic Beat
Truth Serum
Channeling the Fed chairman's true thoughts
By GENE EPSTEIN
Not long ago, a tenant in my building swore he'd just seen Alan Greenspan walk
through our lobby. Now, if you're familiar with my humble high rise on the Upper
West Side of Manhattan, you'd know it for being affordable by a journalist on a
Barron's salary, but not as an address that would likely get visited by the guy in
charge of printing the world's money. The next morning, however, quite by
chance, I also learned that one of my neighbors happens to be the Fed chairman's
father-in-law -- the dad of NBC newscaster Andrea Mitchell. The evening
before, the old gentleman was apparently entertaining family in from Washington.
I pass this enthralling story along for what it's worth: a lot to me, very little to
anyone else. But it does help conjure up a Byzantine fantasy: Picture me pressing
my neighbor to persuade his daughter to sneak truth serum into her husband's
coffee on the morning of his semiannual testimony before the Senate Banking
Committee. Result: Instead of pushing the pablum we heard last Tuesday (in
which he repudiated his recession fears, but predicted slow growth), the
truth-intoxicated Dr. Greenspan talks straight poop, shocking the world in the
process. Key excerpts follow:
"I can't say I welcome the opportunity to present the Federal Reserve's
semiannual report on monetary policy. For starters, I'm a little embarrassed to
admit that I've changed my mind over the past two-and-a-half weeks about the
chances of recession. Right now, I no longer think a recession is very likely.
"Now, you might ask, Just what has occurred since January 25, when I first spoke
the R-word on Capitol Hill? Not very much, as a matter of fact. I just have this
big tendency to get obsessed with particular indicators to the exclusion of all
else, and last month, it was the indices of consumer confidence.
"You might remember how much I used to harp on that meaningless measure, the
'quit rate,' whose ups and downs were a model of statistical insignificance, but
which I regarded as a harbinger of worker restiveness. And I gather the analysts
at the Bureau of Labor Statistics have been tittering for quite some time now
about my pet construct, the pool of available labor. I should probably back off
about that one, too.
"Regarding the plunge in measured confidence, it could have some meaning, but
not when home sales are running near record levels, and not when the MBA index
of mortgage applications has been running so strong, signaling that more sales are
in the pipeline. Each of the past five recessions got preceded by a crash in home
purchasing, the real indication that confidence is plunging. But this morning, I
tried to picture the average person telling the survey interviewer that she's feeling
kind of down about the state of the economy, while asking him to hold the line
because her mortgage broker is returning her call.
"I should add that I've also gained succor from the recent uptrend in real wages,
which can do wonders to buoy consumer confidence. Since paycheck cash tends
to get spent, the markets shouldn't have been surprised by this morning's
reassuring news that retail sales, excluding auto purchases, jumped 0.8% in
January, a sure sign that the November and December slowdown was
weather-related. Now that the consumer is out of hibernation, he'll probably be
back for quite some time.
"Against this background, you might wonder about the recent back-and-forth of
this thing called monetary policy. I wonder about it myself. A little over 12
months ago, the Fed funds rate -- the short-term interest rate I directly control --
stood at 5.5%, which is also where it happens to be today. But last year, in three
successive moves, I hiked it to 6.5% by the middle of May. And last month, in
two swift half-point cuts, I eased it back to 5.5%. So by outward appearances, all
I seemed to be doing was correcting my initial mistake.
"Was the round-trip somehow worth it, or should I have kept Fed funds at 5.5%
the whole time? True, I helped prick the Internet bubble by going to 6.5% -- a
bubble, I should add, that I helped create with my easy money policy. But the
slowdown that resulted got me worried. With hindsight, I probably should have
split the difference, hiking only a half-point to 6%, and not budging from that
level.
"Looking ahead, I anticipate real GDP growth running a mere 2%-2.5% over the
four quarters of this year. If I'm proved right, then the unemployment rate should
rise to 4.5% toward the end of this year.
"On the other hand, you might have noticed that I'm rarely proved right: Over the
past several years, my forecasting record has ranged from lousy to lame. But
those who believe I don't take my prognostications seriously don't seem to
understand how I need to operate. As I try to remind people, since monetary
policy can only work with a lag, one must act preemptively. So the job requires a
crystal ball, however cloudy it might be. Given my outlook for slow growth, you
should expect that I'm likely to dismiss any upside surprises as transitory, and that
I'll hesitate to raise rates in response.
"Maybe I should be chastened by the fact that today's 5.5% level on Fed funds
proved to be low enough to spark the boom that began in early '96, when the
unemployment rate was at the sacred Nairu-level of 5.6%. At that point, I began
to anticipate a 'trend rate' of growth, which meant a stable unemployment rate and
a growth-rate comfortably under 3%. I never got my wish, but I kept wishing it,
always fighting the tape, perennially anticipating the trend rate that wouldn't
happen and the jobless rate that would stabilize, but perversely refused to do so.
"The boom reached a crescendo in the second quarter of 2000, with year-on-year
growth running 6.1%, and with the unemployment rate eventually hitting a 30-year
low of 3.9% by September. Ironically, this turn of events got me canonized as
Flexible Al, the guy who let the boom do its thing. I laughed out loud the other
day over an especially flattering portrait by Nobel Laureate economist Robert
Solow in the New Republic.
"But I wanted to tell him, Look, you idiot, give credit where credit is due. Sure, I
deserve some credit for being agnostic about the level of unemployment that
would spark inflation. But as the record shows, I was enough of a true believer to
draw a line in the sand at every turn. If I'd been able to forecast that joblessness
was headed toward 3.9%, I would have tried to hike rates enough to prevent that
inflationary threat from coming to pass.
"In a word, I got lucky. Last year at this time, I was even lucky enough to make a
right-on forecast about growth in 2000. I foresaw 3.5%-3'% over the four
quarters, and based on preliminary estimates, 3.5% is where it stands. But here
again, don't give me too much credit. I was only repeating my favorite refrain
about the trend rate of growth, and given the rise in productivity, had simply
marked the trend rate up to that level. And by July, I wrongly anticipated better
than 4% growth, and got blind-sided by the weakness in the second half.
"Speaking of credit, there are those who condemn me as Easy Money Al, as the
guy who caused the credit expansion that brought the bubble economy. To them I
say, mea culpa, you're right. It must be especially galling to hear me talk about
irrational exuberance, when I'm the one who's been feeding that crowd their
uppers for quite some time. You might say that when I abruptly began to cut back
on the medicine last year, the patients went into a potentially dangerous
withdrawal. Just this morning, I was rereading my 1962 article on gold in
Capitalism: The Unknown Ideal, in which I argued that the creation of the Federal
Reserve in 1913 was an unfortunate turn of events. Those paragraphs made it
hard for me to look myself in the mirror while shaving.
"But let's clarify a few things. Contrary to a widespread misconception, I don't
directly control the growth of money and short-term credit. I just fix the price via
the Fed funds rate. At that price, I satisfy all who wish to buy, and with hindsight,
the price may have been set too low. But that's quite different from picturing me
as aggressively hurling money on the credit markets in order to feed their frenzy.
"And what would you have had me do instead? Back in the fall of '98, I was
forced to cut Fed funds by three-quarters of a percentage point because the bond
markets were frozen with fear in the wake of the LTCM hedge fund debacle and
the Russian default. In my colorful phrase -- the best I've ever coined -- the
markets seized up, and only a rapid rate cut could get the circulation flowing
again. That put the price of money at a relatively cheap 4.75% on Fed funds,
which no doubt fueled the credit expansion in the first half of '99. But if I hadn't
managed the crisis the way I did, worse could have happened.
"Right now, some of my critics are wondering why I don't exercise the Fed's
power to raise margin requirements as a way of curbing the bull market. But these
ninnies forget that when interest rates are low, margin buying can be conducted by
other means. Instead of financing their purchase of stock at the broker loan rate,
investors can borrow at the mortgage interest rate instead. And now that another
refi revolution is underway, that's exactly what many of them are probably
planning already. So a margin hike would be more symbolic than real, and as
symbolism, it could easily backfire.
"Look, as I've already said, I never really intended this easy money policy in the
first place. But it has brought low unemployment with low inflation. And the
investment it also caused is currently in the process of imploding without bringing
down the rest of the economy.
"In short, I'm not the maestro. I'm just first fiddler. How, you ask, have I suddenly
gained such humility? Frequent visits to my father-in-law's place on the Upper
West Side of Manhattan can humble a man; you get to see how the other half
lives. |
