05/11/19 COMMENTARY: IF THE FED IS BLUFFING, IT'S A WILY MOVE

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COMMENTARY: IF THE FED IS BLUFFING, IT'S A WILY MOVE

Just last December, Federal Reserve Chairman Alan Greenspan was finally feeling comfortable about the stock market because he thought stock valuations were no longer dangerously out of whack with earnings potential. But he had a new worry: that Asia's economic crisis would hit the U.S. economy hard. It prompted the Fed, which had been leaning toward a rate hike, to take a neutral stance about its next move.
But this spring, Greenspan's concerns have flip-flopped. He's less anxious about Asia, which has had surprisingly little impact on the still-robust U.S. economy. Instead, recalling the days of ''irrational exuberance,'' he's fretting that the torrid runup in stock prices could overheat the economy. That change of heart was confirmed on Apr. 27 when news leaked that the Fed had shifted back to a ''bias'' toward raising rates.
Even so, odds are that Fed policymakers won't deliver on a rate hike anytime soon--barring unexpected economic news showing inflation about to shoot up. In fact, despite market jitters and long-bond yields over 6%, the chances of rates going up anytime in 1998 remain low.
PLANTING A SEED. The news that the Federal Open Market Committee voted on Mar. 31 to shift policy--a rare leak from the secretive Fed--may have a serendipitous effect for Greenspan. It took some of the froth out of Wall Street--if only momentarily. The Dow dove on Apr. 27, to 8917, but recovered to 8951 by Apr. 29. Still, the Fed has planted a new thought in the minds of investors: A speculative frenzy can be quickly halted at any time.
But the policy change itself wasn't directed at Wall Street speculators. By agreeing to cock the Fed's gun for a future rate hike, Greenspan was seeking to appease Fed hawks who have been clamoring--ever more vociferously--for a rate hike. That's not to say Greenspan intends to follow through and boost the overnight federal-funds rate, which he has kept at 5.5% for more than a year. ''With no inflation on the horizon, you can't justify a rate hike,'' says an ex-Fed official. ''So he has given the hawks what they want and cooled the market.''
What has the hawks flapping are a recent surge in the money supply, widespread labor shortages, rising wages, and no sign of slowing economic growth. All these trends, they believe, will reignite inflation within a year unless the Fed acts now. In the past, such pressure would have prompted Greenspan to fire a preemptive strike. In fact, he acceded to a quarter-point hike in March, 1997, when such pressure was less intense.
This time, Greenspan seems loath to act early. Why? Despite all the rising statistics--stock valuations, real estate prices, consumer confidence, consumer spending--the one measure that really matters is down. Inflation, as measured by the consumer price index, rose only 1.4% from March '97 to March '98, after rising close to 3% in the previous 12 months. For the rest of 1998, falling oil and import prices will likely offset rising wages. And while Fed officials used to believe that economic expansions ended with a sharp price surge, Greenspan now says a new inflationary buildup would be modest and ''readily reversible.''
SUMMER FALL? The Fed chief is certainly mindful of the steep political price he would pay for boosting rates now. The Fed would be publicly flogged by Congress for an increase in an election year--and at a time when the average worker is finally getting ahead of inflation after decades of falling behind. On Apr. 27, the Commerce Dept. said that inflation-adjusted per-capita income rose 2.5% last year, following a 1.6% gain in 1996. ''Greenspan knows that if he raises rates now and inflation stays down, it looks like an attack on real wage gains,'' says James E. Annable Jr., chief economist for First Chicago NBD. Adds Annable: ''The Fed has got to wait for inflation to show through to retain any credibility with Congress.''
That message might help Greenspan fend off hawks such as Fed Governor Laurence H. Meyer, who fears the economy has ''moved beyond the point of sustainable capacity.'' The hawks don't fully buy Greenspan's argument that the economy's growth potential is higher now because a significant boost in the long-term productivity trend is keeping inflation in check.
The debate within the Fed may become moot if the economy slows down this summer, as many still expect. Indeed, there are already signs of braking: Job creation has slowed, and retail sales turned down in March, as did red-hot new-home sales. If the stock market cools off as well, Greenspan and the inflation hawks can relax.
By Dean Foust

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