Alan Greenspan, the Federal Reserve chairman, defended the central bank on Friday against criticism that it had mishandled the rise and fall of the stock market, saying the Fed could not have prevented the bubble on Wall Street without damaging the economy.
Greenspan said the only way to have reined in the stock market would have been to raise interest rates sharply, a step that he said would have put the entire economy in peril. Smaller but more frequent rate increases, he said, would not have done the trick either.
"The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion," he said.
The other tactic that his critics have suggested he could have used, limiting the ability of investors to pay for stock purchases by borrowing against their holdings, would also have had little effect, Greenspan said.
His speech, delivered here to an audience of government officials and economists at a symposium sponsored by the Federal Reserve Bank of Kansas City, was his most extensive and detailed explanation so far of how he viewed the Wall Street boom of the late 1990s and what the Fed did -- and did not do -- about it.
It addressed head-on the assessment of some investors and economists in the last few years that the Fed had failed to protect the economy and millions of 401(k) accounts from a wild and destabilizing swing in stock prices.
"As events evolved, we recognized that despite our suspicions, it was very difficult to definitively identify a bubble until after the fact -- that is, when its bursting confirmed its existence," Greenspan said. "Moreover, it was far from obvious that bubbles, even if identified early, could be pre-empted short of the central bank inducing a substantial contraction in economic activity, the very outcome we would be seeking to avoid."
Greenspan made no mention of how the Fed is dealing with the bursting of the bubble and the economy's difficulties in recovering from last year's recession. Neither Greenspan nor any other Fed official here said anything to counter the growing impression among investors that signs of halting economic improvement and increasing optimism on Wall Street that stock prices have bottomed out will keep official interest rates on hold in September and perhaps for the rest of the year.
His speech on Friday had an air about it of defending his legacy; at 76, he starts his 16th year as Fed chairman. His main message was that even in retrospect, he could find no way that thecentral bank could have averted the boom and bust on Wall Street without giving up much of the economic gains of the 1990s, including low unemployment and improved international competitiveness.
"It seems reasonable to generalize from our recent experience that no low-risk, low-cost, incremental monetary tightening exists that can reliably deflate a bubble," Greenspan said. "But is there some policy that can at least limit the size of a bubble and, hence, its destructive fallout? From the evidence to date, the answer appears to be no."
Many of economists agreed that rate increases were too crude a tool to contain an unsustainable rise in stock prices. But some economists said Greenspan had glossed over the Fed's role at critical times during the stock market's rise, especially in 1999, when the Fed was seen by some analysts as too slow to raise rates in the face of a red-hot economy and a steep rise in equity prices. And they said the Fed chairman had not fully acknowledged his own role in promoting a bullishness about the economy's prospects and therefore about stock market valuations.
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