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Get Four
|  | FEBRUARY 2, 2006
ECONOMIC INSIGHT By David Wyss Greenspan's Daunting ExampleThe departing Fed chief brought a healthy measure of transparency to monetary policy, and his success will be a challenge to replicateAlan Greenspan has left the Federal Reserve after 18 years and 5 months at the helm, only 5 months short of the record set by William McChesney Martin, Jr. in 1970. He closed out his term by raising the federal funds rate for the 14th consecutive time, to 4.5%, as expected. Nevertheless, the funds rate at the close of Greenspan's term is 2.25 percentage points below the 6.75% level when he took office. Chairman Greenspan's term has been one of the most successful in history, with strong growth, low unemployment, and low and stable inflation. There were only two recessions during his term, both of them relatively mild and brief. During the 221 months of his term, the U.S. economy was in recession only 16 months, the least during any similar period since the Civil War. The 1990s expansion was the longest in history, lasting 120 months. The unemployment rate hit a 40-year low during his term. OUT OF THE SHADOWS. He also changed the Fed itself. His insistence on an eclectic approach to monetary policy proved very successful, despite critics who wanted to move to strict policy rules or an inflation target. More importantly, Fed policy-making became much more open, with clearer announcements of policy actions and their reasons. Before Greenspan, the Fed did not announce federal funds targets or the reasons for changing policy, leaving markets to guess whether it had. Greenspan's changes have made monetary policy much clearer, and, I think, more effective, even if they have reduced the demand for Fed watchers. The earlier release of the Federal Open Market Committee minutes has also made the reasoning behind policy actions clearer. DEFT PILOT. Clarity had its limits, though. When a senator said that he understood the chairman's comment, Greenspan famously replied: "If you understood what I said, I must have misspoke." Still, Greenspan was very careful to keep financial markets informed, telegraphing every Fed move. Almost never did the FOMC surprise the markets. The policy of "no surprises" was a major factor in keeping financial markets smooth. The various crises during his term were handled very smoothly as well. The Asian currency crisis and the collapse of hedge fund Long-Term Capital Management in the late 1990s were perhaps the most severe test. The Fed acted quickly to add liquidity to the markets, and in the case of LTCM, engineered a quick takeover to unwind the open positions. In fact, the LTCM "bailout" never put any Fed money at risk and didn't cost the market any cash, but it could have precipitated a major crisis if the positions had been liquidated more quickly. The Fed also participated in the savings-and-loan bailout of the early 1990s, although the major part of that effort was under the Resolution Trust Corporation. That bailout ended up costing the taxpayer, but the S&Ls were outside of the Fed's control. MINIMIZING DAMAGE. Greenspan's term wasn't perfect. Only two months after he took the helm, the drop in the dollar and a Fed rate hike helped trigger the 1987 stock market collapse, the biggest one-day drop in history. His support for tax cuts helped create the deficits he opposed later in his term, although he did back smaller and more temporary cuts than eventually occurred. He presided over the stock market bubble of the 1990s. However, Greenspan pointed out the "irrational exuberance" of the market early, in 1996, and probably did not have the ability to stop the bubble without causing more damage to the economy than occurred when it broke. One of his greatest feats was limiting the damage caused by the 2000-02 bear market and the September 11 attack. The 2001 recession is the mildest in history. Only five Fed chairmen have served at least eight years. Looking at their records, it is surprising how similar they are in real growth. Chairman Greenspan's record is good, but not out of line with his predecessors. Perhaps this should not be surprising -- unsuccessful Fed chairmen don't get reappointed. Notice that the first two both have Federal Reserve buildings named after them.
Notes: (1) S&P 500 for Burns, Volcker, and Greenspan, S&P Index of Common Stocks for Eccles and Martin. (2) Federal funds rate for Volcker and Greenspan, discount rate for Burns, Eccles, and Martin. Greenspan leaves his successor an economy that is in excellent condition, but with some outstanding problems. The twin deficits dominate the financial risk. Greenspan has been noticeably complacent about the trade gap, but worried about the federal deficit. I am somewhat in the opposite camp; I think the trade deficit is the bigger problem in the medium term. FIZZLE OR POP? Oil prices are another wild card. The Fed can do nothing about oil prices, but does have to respond to their swings. So far, there has been no significant seepage of oil prices into core inflation. And as long as the Fed remains focused on the core rate, it can keep the problem under control. However, if oil prices really surge -- to $100 or more -- it may be more difficult to mop up the oil spillover. Finally, Greenspan leaves new Chairman Ben Bernanke a housing bubble similar in many ways to the stock market bubble. Although we expect this bubble to fizzle rather than pop, there is a risk that sharply higher mortgage rates -- triggered, for example, by difficulty in financing the trade gap which could push bond yields up -- could create a bigger correction.  Wyss is chief economist for Standard & Poor's All of the views expressed in this research report accurately reflect the research analyst's personal views regarding any and all of the subject securities or issuers. No part of analyst compensation was, is or will be, directly or indirectly related to the specific recommendations or views expressed in this research report. Standard & Poor's Regulatory Disclosure Any advice, analysis, or recommendations contained in articles labeled "Insight from Standard & Poor's" reflect the views of Standard & Poor's, which operates separately from and independently of BusinessWeek Online. It is possible that BWOL may from time to time publish information that is not consistent with advice, analysis, or recommendations that are published by Standard & Poor's. Standard & Poor's and BusinessWeek Online are each units of The McGraw-Hill Companies, Inc.
BW MALL
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