-Caveat Lector-
February 21, 1999
ECONOMIC VIEW
A Speech We'll Never Hear From Alan Greenspan
By RICHARD W. STEVENSON
W ASHINGTON -- (italics)Despite his reputation for deliberate
opacity, Alan Greenspan, the Federal Reserve chairman, actually
speaks quite directly about the outlook for the economy and
interest rates. Still, there may be limits to any Fed chairman's
forthrightness. Rest assured that when he goes before the Senate
Banking Committee on Tuesday for the first round of this year's
Humphrey-Hawkins testimony, he will not say the following, no
matter how much he might want to.(end italics)
Thank you. I always enjoy this opportunity to indulge members of
Congress in the fantasy that they understand monetary policy, and
to prepare Wall Street for the next trick up my sleeve.
Let's start by reviewing 1998. You might remember me saying in
September that no nation could remain an oasis of prosperity
unaffected by what was going on in the rest of the world.
Boy, was I wrong! Japan remains in the tank, and the rest of Asia
is only starting to breathe on its own. Emerging economies from
Russia to Brazil are already in free fall or teetering on the
brink. Europe is doing nothing to help, and may itself be headed
for a downward slide. Yet the American economy is not only
shrugging off the rest of the world's woes, it is also showing
remarkable strength.
The economic growth rate in the fourth quarter -- 5.6 percent,
annualized -- may wind up being revised downward somewhat. But
heading into 1999 the United States was not just an oasis, it was a
veritable economic Garden of Eden.
Speaking of sin, I'll confess to my own. That last interest rate
cut -- the quarter-point reduction in the federal funds and
discount rates in November -- was a mistake. The economy certainly
didn't need it. And while I'm sure my central-banker friends around
the world appreciated it, its main effect at home was to send
stocks higher.
I really should have held off, keeping that quarter point in my
ammo belt just in case Brazil melts down or some other
conflagration breaks out in the global financial system, and we
need another shot of monetary easing. Now, if I have to cut rates
further, Wall Street is going to spurt up into cloud-cuckoo-land.
Everyone knows my feelings about equity valuations, but let me try
this one more time: You people are bonkers if you think earnings
are going to hold up over the next year, much less increase at a
double-digit pace. So if you're buying on the basis of
price-to-earnings multiples, stop deluding yourselves -- you're all
day traders now.
Since we central bankers have to consider all the possibilities,
let's look at another: that growth remains so strong this year that
the hawks start agitating for a rate increase to head off any
chance of inflation taking root.
Raising rates now, while there are no signs of inflation to speak
of, would bring the wrath of the business establishment down on me
and make the Fed a political issue heading into the 2000 election.
I'm willing to take the heat for a tough call if necessary. But we
might have been able to avoid the need for tighter policy if we had
just stayed pat last fall after the first two quarter-point rate
cuts, which left the Fed funds target rate at 5 percent.
Then there is the question of how investors would respond to even a
small rate increase. One thing I've learned is that it is
impossible to let the air out of a stock market bubble slowly. When
this thing goes, it could well explode with a bang that will hit
the real economy hard.
Who knows? Even a small rate increase at the wrong time could set
off a chain reaction that we would regret deeply.
Clearly, that's one reason you are all listening so attentively for
any sign that we see a need for tightening later this year. The
monetarists on the Open Market Committee are already pressing for
us to adopt a tightening bias, and with some justification.
The Phillips Curve crowd, led by Larry Meyer, keeps asking how long
our streak of good luck on inflation will last, and they have a
point. There has to come a day when all the world's economic winds
will not chance to blow our way at the same time. Oil prices will
not remain depressed forever. The dollar could weaken, or global
demand could recover; either would drive up the prices we pay for
imported goods. And eventually it will dawn on workers that they
now have the upper hand and can demand higher pay. Even I don't
think we can sustain a 4 percent annual growth rate and a 4.3
percent unemployment rate forever without seeing wages and prices
start creeping higher.
But this economy has proved remarkably resilient, and I am inclined
to bet that we can make it at least until summer without a
compelling need for a rate increase.
No guarantees, now -- the potential for surprises, both happy and
nasty, is too great. But with inflation virtually nonexistent,
we've got an opportunity to be patient, and plenty of time to react
if wage and price pressures start to build.
So until things break one way or the other, we're on hold.
Any questions?
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