Why Greenspan Is Holding His Fire
By Rich Miller
For all his vaunted talents, Federal Reserve Chairman Alan Greenspan has never had much of a reputation as an economic forecaster. In fact, he shies away from making the precise to-the-decimal-point predictions that many other economists thrive on. Instead, he owes his success as a monetary policymaker to his ability to sniff out threats to the economy and manipulate interest rates to dampen the dangers he perceives.
Now, those instincts are being put to the test. Many Fed watchers -- and some policymakers inside the central bank itself -- are beginning to wonder whether Greenspan has lost his touch. Despite rising risks to the economy from a swooning stock market and soaring oil prices that could hamper growth, the Greenspan-led Federal Open Market Committee (FOMC) opted to leave interest rates unchanged on Sept. 24. But in a rare dissent, two of the Fed's 12 policymakers broke ranks and voted for a cut in rates -- Dallas Fed President Robert D. McTeer Jr. and central bank Governor Edward M. Gramlich.
The move by McTeer, the Fed's self-styled "Lonesome Dove," was no surprise. But Gramlich's was. This was the first time that the monetary moderate had voted against the chairman since joining the Fed's board in 1997. And it was the first public dissent by a governor since 1995 (see BW Online, 9/25/02, "Rebels with a Cause at the Fed").
Despite the split vote, it's too soon to count the maestro of monetary policy out. Greenspan had good reasons for not cutting interest rates now. And by acknowledging in the statement issued after the meeting that the economy does indeed face risks, Greenspan left the door wide open to a rate reduction in the future. Indeed, former Fed Governor Lyle Gramley thinks chances are good that the central bank might even cut rates before its next scheduled meeting on Nov. 6, the day after congressional elections.
So why didn't the traditionally risk-averse Greenspan cut rates now as insurance against the dangers dogging growth? For one thing, he still thinks the economy is in recovery mode. Consumer demand remains buoyant and has even been turbocharged recently by a new wave of mortgage refinancing. Economists reckon that homeowners will extract some $100 billion in cash from their houses in the second half of this year. And despite all the corporate gloom, business spending has shown signs of picking up, though not anywhere near as strongly as the Fed would like.
Yes, the recovery has been uneven. And yes, the Fed, like most other forecasters, expects growth to slow markedly in the fourth quarter from the third. But to Greenspan's thinking, the up-and-down pattern of growth is mainly the result of the mildness of last year's recession. The bounce you'd normally expect from a recovery is missing because the downturn was so shallow.
What's more, as was evident from the statement the FOMC issued after Tuesday's meeting, Greenspan and his monetary minions are still counting on strong productivity growth to help carry the economy through its travails. This strength is enabling companies to cut labor costs and boost the bottom line. Those higher profits eventually should entice business to step up capital investment, the economy's biggest weak point now.
What's good for profits, though, is bad for the jobs market, at least in the short run. Pumped-up productivity means companies can get by with fewer workers. That's why employment growth is lagging and why the jobless rate is likely to tick back up. But Fed officials are betting that Corporate America can wring only so much out of the existing workforce and that eventually, companies will need to step up hiring.
Of course, Greenspan's relatively sanquine outlook entails risks. But they come mainly from things outside the Fed's direct control -- such as the stock market and the uncertainties surrounding the Middle East.
In his speech to the Kansas City Fed's conference in Jackson Hole at the end of August, Greenspan seemed to suggest, based on economics alone, that the stock market was more or less fairly valued. But being a long-time observer of the market, he's well aware that other factors, including sentiment, can affect valuations and that share prices can overshoot on the downside as well as the up.
What's particularly worrying the market right now is fear of a war with Iraq, which hangs over the economy like a wet blanket and gives executives, already shell-shocked by fallout from corporate scandals, yet another reason to hold back on spending and hiring. But the Fed can't do much about that.
Does that mean that further rate cuts are off the table? Hardly. Watch for Greenspan to try to time any rate reductions to when they'll have the most psychological pop on business and investor confidence. That's surely no easy feat, but it's one that Greenspan has shown himself capable of more than once in the past. Don't be surprised if he surprises everyone again.
Miller covers the Fed from BusinessWeek's Washington bureau
Edited by Douglas Harbrecht