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Many investors were stunned when Federal Reserve Board Chairman Alan Greenspan unexpectedly engineered a full percentage-point cut in interest rates in two half-point moves during January. After all, the hallmark of the cautious Greenspan's four-term tenure has been the quarter-point shift in the central bank's benchmark interest rate. The respected chairman's newfound boldness unleashed a torrent of Wall Street speculation. Was Greenspan panicked? Did he know something about the economy the rest of us didn't?
Nope, replied the Fed chief. In his recent semi-annual testimony on monetary policy before the Senate Banking Committee, Greenspan announced that the New Economy simply demanded a more forceful monetary policy. Thanks to the remarkable progress in information technology and the unyielding efforts of managers to restructure their operations around these technological advances, businesses and consumers react far more quickly to changes in the economy than ever before.
"[T]he Federal Reserve has seen the need to respond more aggressively than has been our wont in earlier decades," said Greenspan. He quickly added: "The very advances in technology that have quickened economic adjustments have also enhanced our capacity for real-time surveillance."
STILL CLOUDY. Oh, really? That last claim is certainly dubious. Despite vast leaps forward in the speed and quality of information over the past quarter-century, "our capacity for real-time surveillance" hasn't been enhanced a whit. Scant evidence shows that professional soothsayers are any more accurate at forecasting the economy's future than they were before. Indeed, a session called "How Clear Is The Crystal Ball" at the recent American Economics Assn. annual meeting suggested that the profession's forecasting track record has deteriorated, not improved, in recent years.
Yes, tons more good data are available to consumers and business in a wired world. But in a $10 trillion economy, it's as hard as ever for the Fed to separate out with any speed and exactness the good information from the weekly and monthly noise, misinformation, and confusion. Greenspan may be a legend among central bankers, but the owl of Minerva still flies at dusk. At the end of each day, we still barely understand what will happen tomorrow.
Greenspan is surely on target when he says in the Information Age the economy is increasingly responsive. Just-in-time inventory management techniques, along with the creation of direct pipelines to suppliers and consumers, allow businesses to respond rapidly to shifts in supply and demand. The labor market is more adaptable, too, partly reflecting the rise in temporary employment and contingent workers over the past quarter-century.
WRONG LESSON. Capital flows are less volatile at home and abroad as the stock and bond markets replace traditional bank lending. Research by Massachusetts Institute of Technology economist Olivier Blanchard indicates that the long-term trend among the major industrial nations has been toward declining volatility in output. "The economy is becoming more stable," he says. "The notion that the New Economy is more unstable doesn't strike me as self-evident."
In a sense, Greenspan is taking the wrong monetary lesson from his deep grasp of the high-tech high-productivity revolution. A more efficient economy means businesses and consumers will adapt quickly to emerging imbalances, such as too much investment in high-tech gear, steep household leverage, or high oil prices.
Thus, the economy is prone to find a new equilibrium or balance on its own -- without the active intervention of the Fed. "I see a quickened pace of adjustment as a positive and a reason for the Fed to hold back," says Peter L. Bernstein, an economist and investment adviser based in New York. "After all, the reason for the Fed is to make that adjustment happen."
LURCHES AND SWINGS. Greenspan's call for a more aggressive monetary policy runs the risk that the Fed could become a destabilizing influence in the Information Age. Certainly, that was the case from the 1950s through 1970s, as lurches in Fed policy largely accounted for abrupt swings in the business cycle.
Monetary policy in the New Economy should be characterized by watchful inaction. The Fed should stand ready to intervene when the system is threatened with collapse, such as during the U.S. stock market crash of 1987 or the Asian contagion of 1998. But by and large, watchful inaction will be a far safer prescription for stability in the New Economy.
Farrell is contributing economics editor for BusinessWeek. His Sound Money radio commentaries are broadcast over National Public Radio on Saturdays in nearly 200 markets nationwide. Follow his weekly Sound Money column, only on BW Online Edited by Douglas Harbrecht
Copyright 2001 , by The McGraw-Hill Companies Inc. All rights reserved.
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