Commentary: Greenspan: Between The Hawks And A Hard Place

Usually, when the U.S. economy starts rollicking too much, you can count on the Federal Reserve to halt the party before it leaves the economy with an inflation hangover. Not this time. When Chairman Alan Greenspan and his monetary mavens gather on Feb. 2-3, they'll be looking at an economy that's whooping it up: a sizzling stock market, runaway consumer spending, and rising wage pressures. In more tranquil times, the Fed would be debating whether it's time to hike interest rates to cool things off.

But with the global financial system still in fragile condition, the Fed doesn't dare boost rates. "If you just looked at the domestic economy, the Fed would be leaning toward tightening," says former Fed Vice-Chairman Manuel H. Johnson. "Now it has no choice but to keep the economy strong and the stock market up. If it signaled tighter policy, it might set off a bombshell."

For now, inflation is benign, so there's no risk in keeping rates steady. But later this year, the rate-setting Federal Open Market Committee could find itself unable to thwart rising inflationary pressures. Some Fed officials privately concede they may need to tighten if the economy refuses to slow on its own. But that option is inconceivable if much of the global economy is in recession or turmoil.

Greenspan is even prepared to cut rates again if required to stabilize the world financial system, regardless of the new buying spree likely unleashed on Wall Street. "The risks of letting the global economy falter are far greater than the risk of letting inflation out of the bottle," says one Fed official.

That's a comforting view for investors around the world: With Asia in a deep slump and Europe slowing, everyone is depending on the powerful U.S. economy to prevent the first global downturn since World War II. "Even a hint that the U.S. might go into a recession is unthinkable," says former Fed Governor Lawrence B. Lindsey. "The Fed has become the guarantor of both the world economy and the U.S. stock market."

That role makes some fomc members nervous. Their concerns began to grow after Greenspan requested a quarter-point rate cut in November, the third in three months. Fed sources say the move was a tough sell. Now, several fomc members have misgivings about the cut because of a later runup in stock prices and signs of strong economic growth.

SPARK. Greenspan isn't fretting about inflation right now. His chief worry is a stock market that's rising much faster than corporate profits. The higher stocks soar, he fears, the farther they can fall, causing a reverse "wealth effect" that would spark a U.S. slowdown.

Despite his anxieties, Greenspan recognizes that he may have to give Wall Street another unintended boost if a new crisis requires a rate cut. It's a trade-off worth making. When you have to play central banker for the world, frothy stock prices aren't so bad. The alternative is a lot scarier.

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