It sounds like a line from a cheesy political thriller. But the proposal is serious, an intriguing if flawed pitch for a radical change in the way this nation sets monetary policy.
Of course, no one really wants to do away with Greenspan, the Federal Reserve chairman. But 14 years into Greenspan's tenure at the helm of the Fed, his once-unblemished reputation has faded, albeit only slightly.
The Fed's ability to raise and lower short-term interest rates is its primary control over the economy. An increase in rates raises borrowing costs for consumers and businesses, causing them to defer spending and slowing growth and inflation. A cut in rates has the opposite effect. Greenspan's goal is to keep the economy growing as fast as possible without causing inflation to rise.
The job has always been tricky. And it has only gotten harder, because stock investors are now intensely conscious of the Fed's interest-rate moves. Rising stocks encourage consumers to spend more, while a falling market hurts consumer spending. That indirect ``wealth effect'' can overwhelm the Fed's direct control over borrowing costs. But the Fed cannot always predict how stock investors will react to a change in short-term rates.
Greenspan raised short-term rates too slowly in 1999 and 2000, leading to the Nasdaq's bubble, critics say. He compounded the error, they add, by failing to cut rates last fall, hobbling the economy. Now, by making five rate cuts this year, he has overcompensated and risks another bubble.
Balancing growth and inflation is simply too much for one man, even Greenspan, says Jonathan Hakala. Hakala spent more than a decade as a Wall Street bond trader before quitting in 1998 to start a venture capital fund. Rather than relying on Greenspan, he suggests allowing the market to set short-term rates, as it now sets long-term rates.
Here's how Hakala's plan would work: The Fed would announce a target interest rate for the 10-year Treasury note of 4 percent. If the Treasury note traded at a rate other than 4 percent, the short-term rate the Fed now controls would be set at double the difference between the 10-year rate and 4 percent.
For example, if the 10-year note carried a rate of 5 percent, the Fed's short-term rate would be set at 6 percent. If the 10-year had a rate of 3 percent, the short-term rate would be 2 percent. Over the long run, the Fed's goal would be to keep both short-term and long-term rates at 4 percent and inflation as close to zero as possible. And because rules for setting short-term rates would be public, investors would have more certainty about what the Fed wanted.
"There's overwhelming pressure for a market-based, transparent, no or low-inflation economy, and the people who try to resist it are dinosaurs. It's inevitable," Hakala said. "We need something that is not a personality cult around one very talented individual."
Hakala's plan so far has not won much support on Wall Street, where the accepted wisdom is that using a single mechanism to set short-term rates would a mistake.
The interest rate on the 10-year note does not change solely because of investors' expectations of inflation, said David Wyss, chief economist for S&P's DRI. For example, a financial panic in Japan could cause Japanese investors to sell their American Treasury securities and push up rates on the 10-year note. Under Hakala's rule, that would cause the Fed to raise rates just when it should be lowering them, Wyss said. Also, the rate of productivity growth changes over time, so the economy's natural inflation-free growth rate is not fixed. Hakala's plan does not account for that, Wyss said.
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