Commentary: Chalk One Up For Greenspan

Federal Reserve Chairman Alan Greenspan is an acknowledged master at reading the economic tea leaves. But he's no slouch at figuring the political angles either. Little wonder, then, that the Fed's decision on Sept. 24 to forgo an interest-rate hike looks like both smart economics and shrewd politics.

The question before the rate-setting Federal Open Market Committee was one of the toughest it had faced in years: Is the economy so strong and labor so tight that a rate boost is needed six weeks before Election Day to keep inflation in check? The Fed has been embroiled in an unusually public feud on this point, with several regional bank presidents clamoring for a rate hike and Greenspan cautioning the group to wait. "This was as tough a call as I can remember," says a White House economist who closely tracks the Fed's deliberations. "Both sides had strong arguments."

History, the bank presidents argue, has shown that the economy can't sustain its second-quarter 4.8% growth rate and a 5.1% jobless rate without fueling inflation. That's why they want to raise the federal funds rate, which banks charge one another on overnight loans, from 5.25% to 5.5% or 5.75% as insurance against rising prices lurking around the corner.

"FUNDAMENTALLY SOUND." But Greenspan prevailed--to the surprise of many armchair central bankers on Wall Street who had predicted a quarter-point boost in short-term rates. Simply, the Fed chairman makes the better economic case. Signs abound that economic growth in the third quarter is slowing. Indeed, weak retail sales and a surprisingly large trade deficit in July have prompted the Clinton Administration to downgrade its internal estimate for growth in the quarter from 3% to just over 2%. That's a level most economists believe can sustain long-term growth without increasing inflation. Why boost rates now?

And where's the evidence of rising prices? During the past 12 months, the so-called core rate of inflation--the consumer price index excluding the volatile food and energy sectors--is actually down from the same period the year before, 2.6% vs. 2.9%. Greenspan's bigger worry: rising wages. But even here, there's no evidence of higher pay raising prices. Administration economists figure wages are going up by an annual rate of about 3.5%, but with productivity up by about 1%, the net cost to employers is just 2.5%. "Looking at the economics," says former Fed Vice-Chairman Manuel H. Johnson, now a private consultant, "the Fed's decision to wait was fundamentally sound."

Johnson is quick to add: "Of course, there could have been political considerations in the decision, too." No doubt there were--not least, internal Fed politics. A week before the FOMC meeting, Reuters News Service reported an astonishing leak from the normally secretive Fed: Eight of the dozen regional banks were lobbying for a rate increase, with three of them calling for a boost as big as half a point. Speculation about the source of the leak immediately focused on the bank presidents, who may have tried to jawbone Greenspan.

The Fed chief asked the Justice Dept. to probe the breach of confidential information. Fed watchers predicted the leak would force the Fed boss to accede to a quarter-point rate hike, but the whole maneuver may have backfired. "I suspect Alan made it clear that you don't reward people who act badly," says one former Fed official.

ANTENNAS. Greenspan is keenly attuned to electoral politics as well. He certainly didn't want to risk becoming a lightning rod in the final weeks of the Presidential campaign, with GOP nominee Dole blaming him--as well as President Clinton--for sluggish economic growth.

Then there's Capitol Hill. With Democrats hoping to recapture Congress, the Fed's chief nemesis, Representative Henry B. Gonzalez of Texas, could be back in charge of the House Banking Committee. Of late, the Fed has been hit by a spate of stories detailing its freewheeling spending on buildings, salaries, and perks--issues that always get Gonzalez' dander up. So why antagonize him further a day after Gonzalez and 79 other lawmakers urged the Fed to keep rates steady? "Greenspan really didn't want to raise rates before the election if he could help it," says an Administration official.

If the regional bank presidents' forecast proves correct and a still robust economy sparks inflation, a chastened Greenspan may have to swallow a half-point hike when the FOMC next meets on Nov. 13. But here's betting he made the right call: Slower growth will become apparent this fall, and the Fed chief will earn political capital for refusing to cave in to the hawks.

Before it's here, it's on the Bloomberg Terminal.