WSJ on Alan Greenspan's "Don't blame me" speech.
September 3, 2002
Greenspan, at Fed's Conference, Says Bubble Was Beyond Control
By GREG IP
Staff Reporter of THE WALL STREET JOURNAL
JACKSON HOLE, Wyo. -- Federal Reserve Chairman Alan Greenspan used
the central bank's economic conference here to make a spirited argument
that the Fed was impotent to prevent the stock-market bubble of the 1990s.
A more troubling question to emerge from the conference is whether the
Fed, even with its recent aggressive interest-rate cuts, is just as constrained
in undoing the damage of the bubble's collapse.
The theme of this year's conference, organized by the Federal Reserve
Bank of Kansas City and attended by retired and active central bankers,
government officials, academics, private economists and journalists from
around the world, was how to smooth the ups and downs of the business
cycle. Nothing has made that harder in recent years than asset bubbles.
Japan is still trying to recover from its 1980s stock and real-estate bubble
despite interest rates near zero and massive government spending.
Controversy still rages over whether the Fed could have prevented the
recent recession by raising interest rates sooner and higher to prick the
stock-market bubble.
In his opening remarks Friday, Mr. Greenspan
said no: "The notion that a well-timed incremental
tightening could have been calibrated to prevent
the late 1990s bubble is almost surely an illusion."
He got support a few hours later from Yutaka
Yamaguchi, the Bank of Japan's deputy governor,
who thought it unlikely that the Bank of Japan
could have prevented that country's bubble. But
Mr. Yamaguchi also made a more troubling
assertion: that the Bank of Japan couldn't have
absorbed much of the damage of the deflating
bubble, either. Even if it had slashed interest rates
far faster in either 1991 or 1994, it would have at
best produced one or two years of strong growth,
by his estimates, but declining asset values would have then pushed the
economy back into stagnation. "Could aggressive easing have significantly
moderated the fall of real-estate prices and therefore the balance-sheet
problem?" Mr. Yamaguchi asked. "I am skeptical. We have witnessed time
and again that after an asset inflation has developed into a major bubble, it is
impossible to soft-land that market."
Among U.S. academics and Fed officials, it is an article of faith that a
central bank can prevent a slide into deflation by slashing rates quickly and
steeply and accepting the risk of extra inflation later. The Bank of Japan
failed to do so, they believe, out of a misguided fear of restarting the bubble
and fueling inflation. "I'm a little concerned about the argument against
aggressive easing," an argument which amounted to "fighting the last war,"
Fed governor Donald Kohn said, adding that lower rates can help the
economy even if they don't stop the fall in asset prices.
Fed officials are confident the
U.S. won't relive Japan's
postbubble experience, in part
because they think they have
learned from it. They cut rates steeply after the Sept. 11 terrorist attacks
and have left them there in part to prevent a slide into deflation that would
have made it hard to stimulate spending later on, even with zero rates.
That risk, while not entirely absent, has largely receded; Fed members have
little sympathy for prognostications of "double-dip" and deflation, and they
demonstrated it by leaving rates unchanged at 1.75% at their Aug. 13
meeting. They acknowledged risks were tilted toward economic weakness,
rather than inflation, but since then, stable stocks, lower corporate-bond
yields and firm economic data have left them satisfied their decision was
the right one. That suggests they will probably leave rates unchanged at their next meeting Sept. 24.
Central bankers must act on probabilities, not certainties, and it is probable that with its more flexible
monetary, fiscal and regulatory policies and stronger financial system, the U.S. won't follow Japan's path and
that by next year, will be growing a healthy 3% to 3.5%. But it is also possible the burst bubble has done more
damage than realized. "History is sobering on bubble aftermaths," said former Treasury Secretary Lawrence
Summers, now president of Harvard University. "It often records false dawns when people thought the worst
was past, and turned out to be wrong."
Mr. Greenspan used to think the Fed could safely deflate a bubble; one of the reasons it doubled interest rates
in 1994-95 was "to break the cocoon of capital-gains speculation," Mr. Greenspan said at the time, according
to transcripts of policy meetings. But that episode changed his mind. Stocks moved sideways as rates rose.
But when rates peaked, and a recession didn't ensue, stocks resumed their rise.
If anything, that episode fueled the bubble by convincing investors that the Fed's success at extending the
noninflationary expansion justified even higher stock values. In his speech Friday, Mr. Greenspan said that
even if a central bank identifies a bubble as it forms -- a difficult task -- raising interest rates wouldn't deflate it
unless they also tipped the economy into recession -- "the very outcome we would be seeking to avoid."
The speech was a rebuttal to critics who have argued the Fed could have prevented much of the recent
carnage in the economy and markets by raising rates sooner.
One of them, the International Monetary Fund's former research director Michael Mussa, said, "I thought [the
speech] was far too defensive. Mr. Greenspan has been a great chairman of the Federal Reserve. The Fed
made a modest mistake in monetary-policy management in not tightening a little sooner."
But former Israeli central-bank Governor Jacob Frenkel argued that by setting out to burst real bubbles, a
central bank will almost certainly burst some nonbubbles, hurting risk taking and prosperity.
The speech was also a reminder of how unsure the Fed should be about the future. "We were confronted with
forces that none of us had personally experienced," Mr. Greenspan said of the bubble's formation in the late
1990s. "Aside from the then-recent experience of Japan, only history books and musty archives gave us clues
to the appropriate stance for policy."
Write to Greg Ip at greg.ip@wsj.com
Updated September 3, 2002
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