It's rare when traders, investors, analysts and the entire financial press come away with the same interpretation of a speech by Federal Reserve Chairman Alan Greenspan. When one considers that Greenspan prides himself on his ability to say all things to all people, a universal consensus on his message is downright inconceivable.
Last week was one of those rare instances when Greenspan spoke with one voice. There will be no rate increases before their time, the chairman said in congressional testimony. At minimum, the Fed is not ready to withdraw the extraordinary degree of monetary stimulus injected into the economy following the 9/11 terrorist attacks. The idea of a preemptive tightening -- before inflation starts to accelerate -- is positively pass?.
What's also pass? is Greenspan's longstanding approach to policy -- as defined if not as practiced. "He has long argued that the most successful monetary policy is one that looks forward, not backward," says Joe Carson, an economist at Alliance Capital Management. "According to Greenspan, the true task of successful monetary policy has to do with policy makers' ability to limit the movement of long-term rates from what would otherwise have occurred with a less forward-looking monetary policy."
The late British economist John Maynard Keynes, when asked about an apparent inconsistency, said: "When the facts change, I change my mind." Greenspan has to be aware that when the policy response changes, it will yield different economic and financial results, according to Carson.
To prove his point, Carson compared the latest Greenspan missive to his semi-annual monetary policy report to Congress in February 1994, another period when monetary policy was excessively easy to allow the banking system to recover from the bad real estate loan debacle of the late 1980s.
At the time, the chairman was careful to delineate the time lags with which policy operates.
"Monetary policy affects inflation only with a significant lag," Greenspan said. "That a policy stance is overly stimulative will not become clear in the price indexes for perhaps a year or more. Accordingly, if the Federal Reserve waits until actual inflation worsens before taking counter measures, it would have waited too long." Clearly the facts have changed, causing Greenspan to change his mind about the conduct of policy. Maybe the New Economy, with its strong productivity growth, gives him more flexibility in administering interest-rate medicine to the economy -- both its timing and its dosage schedule. After all, if inflation expectations have been reduced by an extended period of low inflation, businesses and consumers will be slow to catch on when inflation accelerates, thereby dampening the vicious cycle.
According to both market-based measures and consumer surveys, inflation expectations aren't nearly as dormant as the chairman suggests. The spread between the Treasury's 10-year note and 10- year inflation-indexed bond -- the difference between nominal and real yields generates a market expectation of inflation -- has widened by 60 basis points in the last 2 months. Granted, at 2.1 percent, inflation expectations are hardly problematic.
Taken in conjunction with a weaker dollar and higher commodity prices, however -- two trends in evidence in 1994 as well -- perhaps the chairman should not be quite so blas?.
RSS