BusinessWeek: March 14, 1994

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ENOUGH IS ENOUGH, MR. GREENSPAN

When Federal Reserve Board Chairman Alan Greenspan tightened monetary policy on Feb. 4, there was a widespread belief that the move would curb inflationary expectations and actually lower long-term interest rates. It turns out everyone was wrong.

Since Greenspan raised short-term interest rates by 25 basis points, long bond rates have risen nearly twice as much, jumping to about 6.8%. Instead of soothing the savage beasts of the bond market, Greenspan's move appears to have induced a frenzy.

What has gone wrong, and how can it be fixed? It's tempting to say that Greenspan's preemptive strike against inflationary expectations was wrong from the start. Not so. What really spooked the markets was his subsequent confession that he believed monetary policy had been too loose, too long.

The markets inferred that Greenspan's strike was only the first in a series of attacks against inflation. Market players around the world concluded that the Fed would push interest rates much higher in the months ahead.

Worse, Greenspan added to confusion in the markets by admitting that the conventional monetary measures were no longer reliable and that he was turning to more exotic measures, including that "arcane metal," gold.

All this happened while the consumer price index, the gross national product deflator, and even the price of gold itself were showing a surprising degree of price stability. Certainly the fourth quarter of 1993 came in at a stunning 7.5% growth rate, but that's history. Almost every forecaster is saying that the first quarter will grow at about 3%, if that.

Paradoxically, rates have already shot up so much that the probability of the economy overheating is virtually the same as the January change in the CPI--zero. Indeed, the appropriate worry now is that the economy will slow down too much by summer.

Greenspan surely knows last year's recovery was caused by a fall in long-term rates. That makes a sharp rise in long-term rates the clear and present danger. The bond market vigilantes are screaming for another tightening from the Fed, but it's unnecessary now. Rates have already risen enough so that the main force driving consumer spending, mortgage refinancing, has run out of gas. Get real, Mr. Greenspan: Preemptive strikes should not turn into wars.
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