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Federal Reserve Chairman Alan Greenspan is a cagey fellow. Witness his aggressive "open mouth" policy -- the best example being the recent references in a statement by the Federal Open Markets Committee (FOMC) to the possibility of deflation reemerging. That statement was clearly aimed at more than one audience: It can be seen partly as a public effort to lobby the central bank's other policymakers to ease one more time. And it also can be read as an effort by the Fed chief to talk down bond yields -- and thereby flatten the interest-rate spread between short- and longer-dated Treasury issues.
Presumably, the Fed also would like to boost the small but significant business fixed-investment component of U.S. gross domestic product. Lackluster business investment is the current source of the weakness in the U.S. economy -- atypical when compared to the early years of prior economic expansions. If Greenspan can talk down corporate-bond yields without further reducing the already low Fed funds rate, perhaps he can jumpstart business investment without using up the Fed's tiny remaining arsenal of Fed funds-rate reductions.
Unfortunately, Greenspan's invocation of the threat of deflation has taken on a life of its own among the financial media and market commentators. And his words may be causing a negative impact on business investment that is offsetting the benefit of lower yields -- the opposite effect of what he intended.
OBLIVIOUS CONSUMERS. John Maynard Keynes coined the phrase "animal spirits" as a mathematician's way of recognizing that the statistical relationship between business investment and interest rates is at best tenuous. Keynes noted that the big turns in investment appear driven more by shifts in unobservable "perceptions" rather than observable economic data, such as yields. It might be one thing if Greenspan's strategy for achieving lower bond yields was boosting the already solid consumer sector while further depressing the interest-sensitive business-investment component. His strategy seems to be having an ambiguous effect on overall growth because of the "unobservable" business worries.
Yet most consumers are delightfully oblivious to Fed policy proceedings and Chairman Greenspan's rhetoric. The hefty 70% of the economy represented by the consumer segment is busy taking advantage of recent yield declines to purchase yet more homes and other consumer goods via a massive refinancing binge, just as statisticians would predict. And of course, we at MMS International expect this pattern to be followed by a spending spree as the effects of tax rebates and lower withholding rates kick in through the second half of 2003.
It's not the consumer sector that needs a targeted verbal nudging from the Fed, however. The focus should be the corporate types responsible for most business fixed-investment decisions -- those who currently seem obsessed with Chairman Greenspan's deflation worries. Given that the financial markets had moved beyond the deflation focus of late 2002, when the Fed started the recent "open mouth" campaign, it's plausible that Greenspan is responsible for keeping this obscure business worry alive -- no matter how many times he repeats the word "remote."
STRATEGIC MISCALCULATION? We suspect that the sheer size of the consumer sector and the stimulative effect of low interest rates mean the the net effect on GDP of the Chairman's curmudgeonly comments will be positive. And steady growth in consumer spending should eventually require new business investment, regardless of whether managers dwell on Greenspan's talk of deflation.
Yet we're likely seeing a sizable near-term negative impact on the business-investment sector resulting in part from his economic and deflation warnings. This is something that the Chairman should be mindful of when he appears before the House Financial Services Committee on July 15. The normally astute Fed Chairman may have made a strategic miscalculation in deciding to keep the market focused on deflation risks when acceleration in the pace of economic growth is so sorely needed.
Englund is chief economist for MMS International
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