Alan Greenspan, Chairman of the Federal Reserve, presented a case history of the 2000-2001 economic slowdown to Congress on Wednesday.
He took us through the boom times, when capacity in high-tech manufacturing rose 50 percent (last year); he took us through the bust, when a deterioration in sales, profits and cash flow crimped capital spending, already suffering from a glut of over-investment.
He walked us through monetary policy (accelerated, accommodative, aggressive, front-loaded) and fiscal policy (tax cuts), both of which will affect "economic activity as the year progresses." He outlined the risks ("mostly tilted toward weakness in the economy"). He was optimistic on inflation ("low and likely to be well contained") and on the future, calling the current decline in capital spending a "pause in the investment in a broad set of innovations that has elevated the underlying growth of productivity." He told us what the Fed has done and what it will do.
What he didn't do was tell us anything new or enlightening.
Greenspan did what most private-sector economists have been doing: acknowledging that the slowdown has been longer and deeper than anyone thought; reiterating that the monetary and fiscal stimulus put in place should be sufficient to produce an economic rebound; and cautioning that if it isn't, benign inflation gives the Fed room to ease further.
The only way to explain the positive reaction in the bond market is expectations. Since this is the Fed's semi-annual monetary policy report, not Greenspan's, traders expected it to reflect the views of some of the more hawkish members of the policy-making committee, who back in May were already arguing for a slower pace of easing.
The Fed ended up reducing the funds rate by 50 basis points on May 15, with one member, Kansas City Fed President Thomas Hoenig dissenting, and by 25 basis points on June 28.
The truth is, the Fed doesn't know when inventories will be lean enough so that final demand translates into increased production. But why stress that when everyone is content to think you do? As always, the members of the House Financial Services Committee wanted to hear Greenspan's views on a laundry list of issues, ranging from the minimum wage to Argentina's woes to the dollar to trade to housing to productivity to the budget outlook.
For a change, someone actually asked him about inflation, which is the one thing over which the Fed has control. In response to a question, Greenspan said: "Congressman, there's very little evidence of inflation in our economy in the sense that as you go from layer to layer, you see some inevitable changes in prices, but if you extract out the very substantial direct and secondary effects of energy price increases, which have now crested and are turning down, it's very difficult to find inflationary pressures there." Greenspan can be excused for not perusing Wednesday's report on consumer prices, seeing as how it was released shortly before his Capital Hill testimony. The CPI rose 0.2 percent in June and 0.3 percent excluding food and energy, both higher than expected. Within the core CPI, shelter costs are accelerating at an alarming rate, rising 0.5 percent in May and June. Shelter accounts for 30 percent of the CPI and almost 40 percent of the core CPI.
A study by Willmore at Barclays found that CPI shelter costs closely track the Housing Price Index, a comprehensive index of repeat sales, with a one-year lag. The HPI rose 8.9 percent in the fourth quarter and 8.8 percent in the first quarter from the year earlier quarter, the biggest increases in two decades. Based on the acceleration in the HPI, Willmore says shelter costs are on their way to a 5 percent annual increase regardless of what happens with the economy.
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