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Wall Street History
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09/13/2002
Alan Greenspan / Jackson Hole Speech...Part II
Last week I posted Federal Reserve Chairman Alan Greenspan’s
speech on the Bubble of the 90s and the Fed response. The
chairman basically said, yeah, it was a bubble, but there was
nothing we could do about it. So, with this in mind, I present a
contrary view from some of today’s better analysts of the
financial scene (though I won’t say which one I normally
vehemently disagree with).
PIMCO’s Fed watcher, Paul McCulley, admitted in his latest
missive, pimco.com, that he had to read and reread Greenspan’s
speech to decipher what it meant for the application of monetary
policy overall. Following are some of McCulley’s thoughts.
[On the issue of why the Fed didn’t tighten in the face of the
Bubble.]
“Greenspan acknowledged that there was indeed a bubble (but)
he remained resolute in his argument that his job description
does not include prophylactic tightening action against bubbles,
only morning-after easing
“While (his record) is exemplary on the inflation-control front, I
was surprised to hear him declare that in the absence of an
inflation ‘problem,’ which would justify nasty tightening action,
the Fed is powerless in the face of an equity market bubble.
Indeed, he implicitly argued that the Fed’s very success in
controlling inflation was a source of ether for the equity market
bubble.”
Greenspan: “ It was far from obvious that bubbles, even if
identified early, could be preempted short of the central bank
inducing a substantial contraction in economic activity – the very
outcome we would be seeking to avoid ”
“The notion that a well-timed incremental tightening could have
been calibrated to prevent the late 1990s bubble is almost surely
an illusion But is there some policy that can at least limit the
size of a buble and, hence, its destructive fallout? From the
evidence to date, the answer appears to be no.”
McCulley: “(But Greenspan ignored) regulatory tools, including
most importantly, prudential constraints on credit creation for
stock speculation. I’m talking about hikes in margin
requirements, of course, which Mr. Greenspan once again
categorically rejected as a policy avenue that he should have
explored.”
---
Related to the above, a point I also made in my “Week in
Review” column of August 31, come the comments of economist
Paul Krugman in an op-ed piece for the New York Times.
Krugman was disturbed by Greenspan’s inability, in the
chairman’s words, to “definitively identify a bubble until after
the fact -–that is, when its bursting confirmed its existence,”
along with his claim that the Fed couldn’t have done anything
about it, even if they knew it was in existence.
Krugman: “In September 1996, at a meeting of the Federal Open
Market Committee, he told his colleagues, ‘I recognize that there
is a stock market bubble problem at this point.’ And he had a
solution: ‘We do have the possibility of increasing margin
requirements. I guarantee that if you want to get rid of the
bubble, whatever it is, that will do it.
“Yet he never did increase margin requirements, that is, require
investors to put up more cash when buying stocks.”
And while Greenspan did nothing, Krugman continues, “he then
began giving ever more euphoric speeches about the wonders of
the new economy.”
“Mr. Greenspan’s remarks reinforce a worry that Fed officials
will respond to continuing economic weakness not with action
but with excuses.
“We’ve seen the process all too clearly in Japan rather than risk
trying to solve Japan’s problems and failing, the (Bank of Japan)
has repeatedly redefined its mission so that it doesn’t even have
to try.”
Krugman is worried Greenspan’s Fed is going down the same
path.
---
Stephen Cecchetti, economist, in an op-ed piece from the
Financial Times.
“Central bankers make two arguments for ignoring asset price
bubbles. They say that there is no way to be sure that there is a
bubble out there – and even if there is, they say, there is nothing
they can do about it.
“The first argument rings hollow For example, it is impossible
to avoid forecasting inflation and growth (and) it is important
to realize that buried in the bowels of the forecasts are implicit or
explicit estimates of the asset prices, the implied equity premium
and any potential bubble. These are necessary inputs into any
forecast of consumption, investment, overall growth and
aggregate inflation. Why not just admit that you take a position
on future asset prices and be done with it?”
On the argument that there is nothing the Fed can do, even if
they were to identify a bubble, Cecchetti argues:
“Taking explicit account of the bubble by tightening is a sound
alternative. To the extent that bubbles arise from unrealistic
expectations of future economic growth, interest-rate increases
that moderate current levels of growth can put a brake on them.”
Sounds pretty good to me.
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Lastly, I just want to add a comment made by U.S. News editor-
in-chief Mort Zuckerman (and echoed by countless others)
concerning the Fed’s current interest rate policy, specifically
concerning a statement from their last meeting:
“The risks are weighted mainly toward positions that may
generate economic weakness.”
Zuckerman: “This makes it all the more disturbing that the Fed
opted to confine itself to mere words. Despite sharply lower
growth in the second quarter and the summer stock market
meltdown, there was no rate cut. If a federal funds rate of 1.75
percent was considered appropriate last year, when we had
higher stock indexes and didn’t have the shock of corporate
scandals undermining business confidence, can it possibly still
make sense now?”
---
That’s all for today. Next week, some thoughts on AOL Time
Warner.
Brian Trumbore
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