Greenspan's Course: Steady but Ready

Despite rumblings about another rate cut from other Fed officials, the chairman is likely to stand pat -- unless Iraq goes awry

Ever since the idea of a New Economy dawned in the mid '90s, Alan Greenspan's adherence to its nostrums has made him the undisputed ruler of the roost at the Federal Reserve. Sure, as chairman of the central bank he has always been the first among equals, especially when it comes to setting monetary policy. But his willingness to throw many time-honored economic theories aside in the belief that the U.S. was entering a new era of productivity-powered growth, helped cement his position as policymaker nonpareil.

Now, though, as the U.S. struggles to recover from the excesses of the bubble economy of the late '90s, other Fed officials have been emboldened to question Greenspan's grasp on the interest rate reins. In the runup to the Tuesday, Mar. 18, meeting of the Fed's Open Markets Committee (FOMC), Greenspan has tried to downplay the need for further rate cuts, arguing that the economy's recent weakness is mainly a case of Iraq-induced geopolitical jitters that'll clear up once the war is won.


  Other monetary mandarins aren't so sure. They fear that the economy is still fighting the fallout from the boom years, with companies saddled with too much capacity and consumers burdened by too much debt. And they think another rate cut is needed to keep the economy moving ahead (see BW Online, 3/14/03, "One More Cut, Please, Mr. Greenspan").

The likely result from Tuesday's powwow? A compromise. In deference to Greenspan, the Fed will probably hold off from cutting rates immediately. But it will also make clear in a statement that it's ready to act promptly to ease policy should that prove necessary after the U.S. launches its long-awaited attack on Iraq. "Policymakers likely will change their risk assessment toward economic weakness and probably will announce that they'll closely monitor economic and financial conditions," says Richard Berner, chief U.S. economist for Wall Street broker Morgan Stanley. "That's Fedspeak for saying another easing move could come at any time."

A rate cut could come quickly if a war with Iraq goes awry, sending oil prices skyrocketing and the stock market plunging. In that case, the Fed won't bother waiting until its next scheduled meeting, on May 6, to move. It will act right away, perhaps in tandem with the European Central Bank, in a bid to bolster corporate and consumer confidence both here and abroad.


  Should the war go well, the decision whether or not to cut rates will be more difficult. Much will depend on the reaction of the oil and stock markets. Greenspan is betting that oil prices will tumble once it becomes clear that the U.S. is on its way to winning the war. A keen, longtime observer of the energy market, the Fed chief thinks oil inventories are larger than the wafer-thin levels that the official figures suggest, in part because Saudi Arabia has parked a lot of its recent production offshore in very larger carriers, so-called floating stocks. To Greenspan's way of thinking, that extra supply should be enough to drive prices down once war jitters recede.

The Fed chief and his allies at the central bank also expect stock prices to rally as the fog of war lifts. The steep runup in stock prices on Mar. 13, based on hopes that war might be delayed, suggests that geopolitical concerns, rather than fundamental worries about the economy, are holding the market back. If that's right -- and the war goes well -- then the Fed may have no need to cut rates further.

Greenspan probably won't hesitate to act if it looks like that scenario isn't panning out, however. Should oil prices stay high or the stock market falter after an initial runup, the Fed chief will likely accede to the wishes of his fellow policymakers and agree to a bold half-percentage point cut in short-term interest rates at the central bank's next meeting in May, if not before. After all, Greenspan didn't earn his reputation as a maestro of monetary policy by being cautious or inflexible.

By Rich Miller in Washington, D.C.

Edited by Douglas Harbrecht

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