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A Gloomy Greenspan Weighs His Words

By Michael Wallace The man behind the memorable catch-phrase "irrational exuberance," Federal Reserve Chairman Alan Greenspan, sounded even more somber than usual in his semiannual report about the state of the economy, given to the Senate Banking Committee on Feb. 11. (He'll repeat his performance before the House on Feb. 12.) Maybe it could be attributed to the current gloomy climate.

His prognosis on the economy was admittedly clouded by war risks with Iraq. And his gentle but familiar lecture on fiscal discipline -- with Congress expected to begin work soon on the Bush stimulus plan -- seemed intentionally vague. Overall, the Fed chairman's testimony -- and his responses to senators' questions afterward -- appeared to be more cautious than the markets anticipated, and investors were disappointed.

Market reaction to the Fed chief's words was fairly tepid at first. What motivated sellers was the White House's leak of news about an Osama bin Laden tape that allegedly urges support for Iraq. That development drove stocks into the red and lifted Treasury prices. At one point during his testimony, Greenspan deflected a question on the weak dollar. By the end of the trading day, the greenback had fallen against major currencies over the war-terror link, and crude oil had surged more than a dollar to new recent highs.

FLEXIBLE STANCE. In assessing the economic landscape following the Fed's last "insurance" interest rate cut of 50 basis points in November, Greenspan continued to express disappointment in business spending, compounded by geopolitical tensions and investor risk-aversion. That threesome conspired to "tightly limit hiring and capital spending," which the Fed attempted to counteract with accommodative monetary policy. Accordingly, this stance "seemed to offer worthwhile insurance against the threat of persistent economic weakness and unwelcome substantial declines in inflation from already low levels" -- a rare reference by Greenspan to deflation risks.

The chairman did express some concern about rising energy prices amid war tensions, "amplified" by a lengthy oil workers' strike in Venezuela. But he noted that productivity gains and the ongoing tapping of home equity credit lines here in the U.S. continue to provide some positive counterbalance to weak consumer income and spending levels, while inventory rebuilding by business provided a lesser degree of support.

Saying "formidable barriers" to new business investment remain, as corporate-finance types become reluctant to sign off on new spending with a possible war looming, Greenspan felt that it was more probable that the economy would recover once these clouds receded.

REVISED NUMBERS. He did point to some positive factors for business spending: lower Treasury yields, narrower spreads on corporate bonds vs. their Treasury counterparts, and a general improvement in corporate liquidity. If these omens proved faulty, he expressed confidence in "conventional" monetary and fiscal stimulus. When asked about this in the Q&A session, he implied that the Fed funds rate at 1% -- with a "balanced" risk posture -- reflected continued vigilance on the part of policymakers.

Economic projections released the same day by the Federal Open Market Committee (FOMC), known as the central tendency forecasts of the Fed's policymaking arm, reflected Greenspan's deliberately cautious tone. The latest report lowered the bar on economic growth and inflation, reducing fourth-quarter real gross domestic product growth over the prior year to a 3.25% to 3.5% range, down from 3.5% to 4.0% in the FOMC's July, 2002, monetary policy report.

The average unemployment rate forecast for the quarter was lifted to 5.75% to 6.00%, vs. 5.25% to 5.5% last year, though Greenspan found the dip in January to 5.7% "somewhat more encouraging." On the inflation front, the forecast for the chain-price index component of the personal consumption expenditure (PCE) report -- considered a more accurate gauge of consumer inflation since it tracks actual spending, vs. the hypothetical basket of consumer goods tracked by the consumer price index -- was eased to 1.25% to 1.5%, from 1.5% to 1.75% last year.

"SOBERING" PROJECTIONS. Greenspan appeared intentionally unclear on fiscal policy in his prepared text, though he was pressed for his views on the Bush stimulus plan by Banking Committee members. He repeatedly couched his responses in the context of maintaining fiscal discipline. While he doubted the immediate stimulative impact of the plan, he once again stated his view that elimination of double taxation on dividends was commendable.

He also warned that faster growth alone would not cure growing budget gaps, with tough spending choices seen ahead. Indeed, the "sobering" budget projections likely make Greenspan long for the Budget Enforcement Act of 1990. Amid such a difficult economic and policy climate, the Fed chief also may be pining for the days when he could tweak the markets for being too exuberant. Those days seem long ago now. Wallace is a senior economist for MMS International

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