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The Fed Chief's Firm and Even Hand

By Laura Cohn Federal Reserve Chairman Alan Greenspan once said managing the economy was a delicate task not unlike steering a ship -- turn the bow the wrong way, and you wind up slamming into the dock. So it was no big surprise that the Fed chief took great pains to navigate lawmakers through his economic forecast with the utmost care when he went before the Senate Banking Committee on July 16. He did a yeoman's job under the circumstances.

With the stock market swooning, Greenspan could hardly afford to appear Pollyanna-ish on the off-chance that investors might ignore any upbeat comments he made. That would have hurt his credibility. At the same time, he clearly expressed his previously stated view that, despite the stock market's down days, the U.S. economy is emerging from its slump. Risks? Well, yes, Corporate America is mired in scandals, which have muddied the waters for economic prognosticators everywhere. The end result? Greenspan came off "bullish but grumpy," as High Frequency Economics chief economist Ian Shepherdson put it.

"INFECTIOUS GREED." True to his faith in the miracle of rising productivity, Greenspan began his presentation by pointing out that the economy has successfully "withstood a set of blows" such as the "sharp retrenchment" in investment spending, the plunge in the stock market, and the September 11 terrorist attacks. He asserted that the "mildness and brevity of the downturn" are "a testament to the notable improvement in the resilience and flexibility of the U.S. economy."

Going forward, he added, the economy is likely to "return to sustained healthy growth." Why? As Greenspan testified, consumer spending remains strong, and business investment appears poised to come back.

Wall Street seemed to take his words to heart -- at least at first. When Greenspan began testifying, the Dow Jones industrial average was off by 200 points. But by the end of his testimony, it was down only 132 points. The uptick in the market was so pronounced that it prompted lawmakers to tease Greenspan about his power over investors. At one point, Senate Banking Committee Chairman Paul Sarbanes (D-Md.) joked with colleagues that Greenspan should keep talking so that the Dow would recover even further.

THREAT TO PRODUCTIVITY. By the closing bell, however, the Dow was down 166 points at 8473. No wonder. Not all of Greenspan's comments were positive. The Fed chief warned that corporate scandals and an "infectious greed" gripping the business community could still hurt the economy.

For example, he said worries among top execs about "possible adverse publicity" surrounding their accounting practices could hurt productivity if it diminishes appetite for new investment. In addition, he said if companies don't learn from this latest brush with accounting and corporate malfeasance, they're bound to repeat the same mistakes in the future, further damaging prospects for growth.

On one point, he was emphatic: "Falsification and fraud are highly destructive to free-market capitalism," Greenspan told the lawmakers. By devoting more than one-third of his testimony to this issue, the Fed chief signaled the importance of passing the accounting and security reforms winding their way through Congress -- giving the tougher Senate version of the reform measure the edge over a weaker House bill. Greenspan "boosted chances that current legislative efforts on corporate governance will be completed in an aggressive way," says Robert DiClemente, U.S. chief economist at Salomon Smith Barney.

MISSION ACCOMPLISHED. By highlighting the forces that will buoy the economy in the months to come, however, Greenspan dampened speculation that the central bank's next move will be to lower interest rates. Mission accomplished for Captain Greenspan. As the markets slumped in recent days and the economy showed tentative signs of recovery, investors began to second-guess their assumption that the Fed was done with easing.

Now that the chairman has spoken, any thoughts of lower rates from the Fed -- at least through the end of the year -- have clearly evaporated. Greenspan, once again, has plotted a steady course. Cohn covers Fed policy from BusinessWeek's Washington bureau

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