The Fed Has a Greenspan Conundrum on Its Hands
Markets are cheering a job well done. Policymakers risk a recession by misreading the easing in financial conditions.
Federal Reserve Chairman Jerome Powell speaks during a news conference after the FOMC meeting in December.
Photographer: Alex Wong/Getty Images North AmericaWhen the Federal Reserve was raising interest rates between mid-2004 and mid-2006, then central bank Chairman Alan Greenspan would often lament the conundrum he and fellow policymakers faced. The issue was that no matter how many times the Fed boosted rates (a total of 17 times, to be exact), financial conditions would ease, mainly in the form of lower long-term bond yields.
What central bankers didn’t seem to understand was that it was all a classic case of misinformation. The Fed thought easier financial conditions suggested that markets didn’t believe its resolve to rein in inflation, when it was really the opposite. Markets were beating down long-term bond yields and bidding up stocks because it believed the Fed would get inflation under control.