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ALAN GREENSPAN'S BRAVE NEW WORLDHe's not scared by faster growth. Why? Because productivity gains are keeping inflation in checkBy all conventional indicators, an interest-rate increase should have been a sure thing when the Federal Reserve's Open Market Committee (FOMC) met on May 20. As the 17 central bankers settled around the immense mahogany table in the Fed's conference room, they faced an economy growing at nearly 6% and an unemployment rate below 5%--a level that for the past quarter-century has been a near-certain signal of impending inflation. Indeed, most officials at the meeting seemed to favor hiking rates. Robert T. Parry, the inflation hawk who heads the San Francisco Fed, worried about the low jobless rate. Richmond (Va.) Fed President J. Alfred Broaddus Jr. fretted that inflation could rise if the Fed didn't act. And Fed Governor Laurence H. Meyer--one of the nation's top forecasters--believed that growth was too strong to be sustainable. But after a coffee break, when the group reconvened to decide whether to raise rates, Fed Chairman Alan Greenspan exercised his prerogative to talk first. Speaking from the head of the table in confident, low-key tones, he argued that there was no need for higher rates, noting that the economy showed signs of slowing. More important, he insisted to his colleagues, years of heavy spending on new technology finally could be yielding big productivity gains. When the final votes were cast, the verdict was nearly unanimous: no rate increase. Only Broaddus dissented. This decision was no one-time aberration, as the next FOMC meeting, on July 2, revealed. Armed with an extra month's data showing a slowing economy and a lack of inflationary pressures--but without having seen the June employment report due out the next day--Greenspan once again carried the day. The FOMC voted to keep rates steady. As he approaches his 10th anniversary as chairman of the Fed on Aug. 11, Alan Greenspan finds himself in the unlikeliest of positions: The staunch conservative who once personified industrial-era economic thinking has turned into the avant-garde advocate of the New Economy. ''He is very open to the possibility that we have entered a new economic age,'' says Judy Shelton, a conservative scholar who meets with the Fed chief several times a year. ''He really believes in the organic nature of the market economy.'' President Clinton shares Greenspan's view on the New Economy. He told BUSINESS WEEK on July 2: ''I believe it's possible to have more sustained and higher growth without inflation than we previously thought'' (page 48). Such are Greenspan's success and prestige that he has been able to carry the FOMC into uncharted territory--by allowing faster growth and lower unemployment than the Fed would have permitted in the past. According to Fed insiders, at no fewer than four FOMC meetings in the past 18 months, Greenspan has prevailed over colleagues who wanted a more restrictive policy. Today, ''he rules the room,'' observes former Fed Vice-Chairman Manuel H. Johnson. ''Until he makes a big mistake, he'll continue to get everything he wants.'' It has been a remarkable odyssey for the 71-year-old New Yorker who is guiding the economy through the best times it has seen since the 1960s. After all, the former Ayn Rand devotee spent 30 years as a nuts-and-bolts industrial economist. And in his early years at the Fed, Greenspan was known as the central banker who kept money tight to counter a big-spending government and stamp out inflation. It was an image the Fed chief seemed to relish: Displayed in his office is a framed cartoon from the Bush years that shows him as an economic Cassandra holding up a sign that proclaims: ''The end is near.'' Today, a more unconventional portrait of Greenspan emerges from conversations with dozens of friends, Fed colleagues, and Washington insiders. The Fed boss is becoming more willing to test his thesis that the economy is operating very differently than it did in past business cycles, lessening the risk of inflation. ''There is a sense in which [Greenspan] is the extreme dove,'' says one Fed source. ''He has been willing to let the economy run tighter than what a lot of people have been comfortable with. It's not uncommon to have a meeting where everyone disagrees with him, but goes along with him in the end.'' Greenspan is even showing a softer side these days, talking privately about the social benefits of a low jobless rate--that a whole generation of previously unemployable workers can build skills to carry through life. That's not a concern you would have expected to hear from the man who, as chief White House economist during the recession of 1974-75, created a furor by suggesting that stockbrokers were suffering more from the downturn than the poor. Greenspan, who hasn't given an on-the-record interview in six years, would certainly take offense at any suggestion that he's anything less than an anti-inflation hawk: Indeed, if the economy grows too fast in coming months, he could be quick to raise rates. In conversations with confidants, the Fed chief insists that his core values haven't changed since President Reagan named him Fed chairman in 1987. Back then, Greenspan was willing to err on the side of higher interest rates to keep inflation from spiraling out of control again. Ten years ago, with the budget deficit soaring and an inflation psychology still widespread, he feared that any letup by the Fed could quickly lead to a new round of rising prices. But the Fed chief argues that while his goals are still the same, the economy is not. In Greenspan's brave new world, heightened global competition is restraining U.S. wage growth and limiting companies' ability to pass along higher costs. Corporate America's massive investment in computers and other labor-saving technologies may be boosting productivity far above the measured rate--letting the unemployment rate drop without triggering inflation. And while corporate downsizings may be slowing, Greenspan nonetheless believes the aftershocks may be felt a little longer--as workers continue to value job security more than higher wages. SKEPTICISM. What's more, the Fed chairman is reaping the results of successful deficit reduction, something he has been advocating for decades. Without additional stimulus from profligate government spending, the Fed can afford to ease up on the monetary restraint it had to apply during the megadeficit 1980s and early 1990s. And Greenspan is convinced that the financial markets--which can react instantaneously to developments--are now playing much of the Fed's old role of stimulating or restraining the economy. That puts the central bank in the enviable position of simply playing referee--gently nudging rates up or down to prod the markets to do its work. Greenspan's new vision generates skepticism among present and past colleagues, who are reluctant to toss out economic models that have worked in the past. Some, such as Meyer and former Vice-Chairman Alan S. Blinder, believe that even in today's economy, inflation is apt to accelerate if the unemployment rate falls below a critical level--pegged around 5.2% to 5.5%. Other Fed officials doubt that the productivity payoff is as large as Greenspan thinks. The Fed chief, by contrast, feels freer to change his mind about economic trends because he's influenced less by academic models than empirical data. In fact, Greenspan didn't even get his PhD in economics (from New York University) until 1977, after he had served as chairman of the Council of Economic Advisers under President Ford. Instead, Greenspan combines an eclectic approach to economic analysis with a love of statistical minutiae. As a young steel analyst and later as an economic consultant to such clients as Burlington Industries Inc. and Ryder System Inc., he often used a ''bottoms up'' approach of looking at thousands of pieces of data to draw broader conclusions about the economy. But when he assumed control of the Fed, he had political factors to weigh as well as economics. According to former colleagues, he was fearful that his close ties to the Republican White House--which had drafted him to head a 1983 Social Security reform commission--would impair his credibility with Wall Street. Recalls one former associate: ''Alan did not want to be viewed as another Arthur Burns,'' the Nixon-appointed Fed chief who some blame for letting inflation spiral out of control in response to White House demands for faster growth. To signal his independence from the Reagan White House, Greenspan engineered a sharp rate increase at his first FOMC meeting--a move that critics believe contributed to the Oct. 19, 1987, stock market crash. But he quickly won kudos on Wall Street and in Washington for his calm handling of the crisis: The Fed chief headed off a full-blown panic by promising that the Fed would provide as much liquidity as needed to keep the nation's financial institutions solvent. SNIPING. Any praise for Greenspan from the White House soon died down, however. On the eve of the GOP convention in the summer of 1988, the Fed raised interest rates, upsetting GOP Presidential nominee George Bush and foreshadowing four years of sniping from the Bush Administration. Fed watchers say Greenspan wasn't trying to distance himself from Bush so much as responding to what he perceived as growing inflationary pressures. But Greenspan overestimated the strength of the economy in the early 1990s and was too slow to lower rates after Iraq invaded Kuwait and consumer confidence plunged. The result: a recession and the most sluggish recovery in modern times. To some Bush officials, Greenspan's anti-inflation zeal caused the President's defeat in 1992. Nowadays, Greenspan relies largely on the accretion of detail to draw his conclusions, although he has never given up on finding a magic compass for directing policy. Among his favorite indicators are inventory levels, supplier delivery times, and a measure that relates wages and benefits to productivity. Greenspan has even developed his own private data sources. At his behest, the National Association of Home Builders now conducts a proprietary survey of its largest members to give the Fed an early and more detailed look at housing construction. And each month, General Motors Chairman John F. Smith talks with Chicago Fed President Michael H. Moskow, who conveys information directly to Greenspan. ''Jack gives him our sense of where sales are headed,'' says G. Mustafa Mohatarem, chief economist at GM. ''SCREW LOOSE.'' In his 10 years at the Fed, the number of data series the research staff tracks has tripled, to more than 14,000. Included are about two dozen proprietary series, such as an elaborate inventory-tracking system developed by Greenspan that, Fed insiders joke, only he understands. After banding together with other governors to demand access to Greenspan's inventory system, former Fed Governor Janet L. Yellen-- who left earlier this year to become President Clinton's chief economic adviser--chuckles: ''I decided I didn't want to understand it. It was so complex that it was beyond me.'' Still, Yellen and other colleagues concede that Greenspan's obsession with detailed economic data often allows him to spot, and then frame, critical economic forces long before others do--such as the credit-crunch-induced ''headwinds'' that delayed the recovery in the early 1990s. And when he launched his controversial ''preemptive strike'' against inflation in February, 1994, he defied critics who predicted that he would trigger another recession in an attempt to stamp out inflationary pressures they didn't see. Instead, he pulled off a soft landing that has resulted in one of the longest expansions in history. Often, Greenspan is so far ahead of the curve that he initially plays to doubting audiences inside the Fed. ''When he started talking about 'worker insecurity' in 1994, there were a lot of people on the FOMC who thought he had a screw loose,'' recalls one Fed official. And some Fed insiders muse that, while Greenspan's penchant for citing obscure data series often helps sway FOMC members, some of those indicators can prove inconclusive upon further review. Yet Fed officials agree that over time, Greenspan is more often right than wrong. ''I give him credit for discerning some of these developments sooner than I do,'' admits Broaddus. Such sentiment explains why the FOMC members are increasingly willing to overlook their own doubts and put so much faith in Greenspan's instincts. In January, 1996, Greenspan was in the minority in his desire to cut interest rates for a third--and last--time to shore up the softening economy, but the other board members went along with him. Then last July and September and this past May, while many FOMC members were itching to raise rates, they bowed to Greenspan's request to wait for more conclusive data before acting. Only on Mar. 25 did the chairman consent to a modest quarter-point snugging, justifying it as an ''insurance policy'' in case his forecast of a slowing economy proved wrong. In later weeks, as new data bolstered his outlook, he privately boasted that a year from now, even the March hike might look unnecessary in hindsight. MORE SANGUINE. Surprisingly, given his reputation as a data hound, Greenspan has shown a profound willingness to go beyond the official statistics. For one thing, he thinks the economy is close to true price stability--taking into account his belief that government figures overstate the real rate of inflation by as much as 1.5%. More significant, Greenspan argues that the U.S. is undergoing a productivity revolution not seen since early this century. Although BLS measures of productivity remain stuck around 1%, Greenspan believes that statistical distortions are understating efficiency gains. Admits one uncertain FOMC colleague: ''You can't give me a better story that ties up so many loose ends.'' So confident is Greenspan of his argument that he has required researchers to make a second productivity measure by ''zeroing out'' any industry sector--such as health care--where statistics show falling productivity. Reason? In this cost-cutting era, he can't fathom any sector becoming less efficient. Still, these exercises drive researchers nuts. ''A lot of the staff are skeptical of overmining the data,'' says Governor Susan M. Phillips. ''They'll complain about it, but in hindsight, it has made a lot of sense.'' The suspected productivity payoff is also making Greenspan more sanguine about the rising stock market. When he raised his famous concern last December about whether stocks were in the grip of ''irrational exuberance,'' the Fed chief was worried that corporate profits couldn't keep pace and that a steep correction might ensue. But margins have been rising smartly--faster than Greenspan can ever recall. His only explanation: productivity. The technological revolution has a disadvantage for Greenspan and his Fed colleagues: Given that much of the government's data-collection was designed to track the old manufacturing-driven society, the changes engendered by the computer are making it harder for the Fed and other economic forecasters to follow the new information economy. And the problem will only get worse in coming years, as the central bank struggles to find accurate measures for output and inflation as well as productivity. If Greenspan keeps adapting and his good fortune in steering the economy holds until his term expires in June, 2000, he will have set the record for the longest expansion in U.S. history, surpassing the 1961-69 boom that legendary Fed Chairman William McChesney Martin presided over. And if the good times are still rolling come the turn of the century, Greenspan just might win another four-year term. Certainly many associates think he would be interested, if his health holds. And why would Clinton want to mess with success? The Fed chief's job has been made easier by his close working relationship with the Clinton Administration, which has adopted a policy of never second-guessing Fed policy. Treasury Secretary Robert E. Rubin, a longtime acquaintance, recalls deliberating with deputy Lawrence H. Summers last year about whether to float inflation-indexed bonds. ''We had a very technical issue we needed to get a judgment on,'' says Rubin. ''We called Alan because he has a lot of market savvy and good sense.'' Greenspan's relationship with President Clinton himself has taken a bit longer to jell. Early in Clinton's first term, the relationship was cool: White House aides say Clinton threw purple fits when Greenspan raised rates seven times between 1994 and 1995. But the subsequent soft landing paved the way for Greenspan's reappointment in March, 1996--and Clinton's reelection eight months later. That was a sure way for the Fed chief to endear himself to Bill Clinton. ''The President realizes Alan Greenspan is an acquired taste,'' says one top aide. Indeed, last winter when Clinton was considering ways to repair Social Security, he consulted with Greenspan. For now, Greenspan's primary concern is testing whether his productivity theory is true: He figures data over the next 12 months could be telling. In the longer term, he's betting that as the world moves into the 21st century and the New Economy takes root, more of the old economic rules will fall apart. That will require a shrewd central banker to figure out what's going on. And by all indications, Alan Greenspan wants to be a witness to that revolution.
By Dean Foust in Washington RELATED ITEMS
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Updated July 4, 1997 by bwwebmaster
Copyright 1997, by The McGraw-Hill Companies Inc. All rights reserved.
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