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Business - Dow Jones Business News
Greenspan Says Fed Could Only Contain The Bubble
Thu Dec 19,10:55 PM ET
The jury is still out on whether the Federal Reserve (news - web sites) has dealt successfully with the late-1990s stock market bubble and its aftermath, chairman Alan Greenspan (news - web sites) said, Friday's Wall Street Journal reported.
When the bubble was inflating, the Fed decided puncturing it with higher rates risked serious damage to the economy, and instead has since tried to contain the damage of the deflated bubble with steep interest-rate cuts, Mr. Greenspan said in a speech to the Economic Club of New York.
But, sounding more uncertain than when he first defended the Fed's actions four months ago, Mr. Greenspan said, "It is too soon to judge the final outcome of the strategy that we adopted." The negative impact on spending and investment from the huge loss of stock wealth since early 2000 was ebbing at midyear, he said, but then, "The fallout for stock prices from corporate governance malfeasance, argued by some as having been spawned by the bubble, became more intense." That, in turn, damped capital investment and inventory restocking.
Geopolitical risk, such as the standoff with Iraq, has also "muddied the evaluation of the postbubble economy," he told the group.
Some critics say Mr. Greenspan made the biggest mistake of his career by not raising interest rates earlier and further in the late 1990s, a move that they say would have prevented the stratospheric rise in stocks and the recession that followed their collapse.
Mr. Greenspan Thursday night repeated his defense first made in Jackson Hole, Wyo., in August, that even if a bubble can be reliably identified in advance, bursting it might require raising rates so high it would crush the economy. Indeed, bubbles, Mr. Greenspan suggested, might be the unavoidable byproduct of long economic expansions with low inflation, which act as "tinder for asset price speculation."
Rather than try to prevent bubbles, the Fed has concentrated on cleaning up after them. It began "an aggressive course of monetary easing two years ago" when it realized the plunge in stocks would hurt growth and hold down inflation, he said.
Still, with economic growth falling toward zero in the current quarter, the Fed's postbubble cleanup is looking less effective than it did last summer. The Fed cut its overnight interest-rate target to 1.25% from 1.75% Nov. 6. The evidence since then suggests the economy is "working its way through a soft patch," Mr. Greenspan said.
He noted the labor market has been "subdued" and manufacturing "damped," and that state and local governments are struggling, oil prices have risen, and foreign trade partners are weak. But he also cited signs of a long-awaited upturn in business investment, such as increased business borrowing, though "not necessarily the beginnings of a vigorous recovery." He gave little indication the Fed feels pressured to either raise or lower rates in the near future.
He also reiterated that the U.S. is "nowhere close" to deflation, or generally falling prices, but said deflation is getting heightened scrutiny from central bankers so they can prevent it. He cautioned against overstating the dangers of deflation, noting that with productivity growth high, wages could keep growing even with flat or falling prices.
Economic data released Thursday also gave a mixed message. The Conference Board (news - web sites)'s index of leading economic indicators (news - web sites), designed to foreshadow overall economic activity, jumped by 0.7% last month, the largest gain in a year. Separately, the Labor Department (news - web sites) reported that new claims for jobless benefits last week fell by a seasonally adjusted 11,000 to 433,000. But the level was higher than analysts expected. On the surface that suggests a still-weak job market, but may also be a result of the difficulty of adjusting for seasonal hiring patterns.
Wall Street Journal Staff Reporter Greg Ip contributed to this report.
Dow Jones Newswires
12-19-02 2255ET
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