His immediate task ahead appears simple: wean the economy off its dependence on very cheap money without undermining the recovery or allowing inflation to take off. He'll probably start off at the Fed's June 29-30 meeting with a small 25 basis-point hike in the short-term federal funds rate, to 1 1/4%, and follow with a series of modest hikes through 2004 and perhaps into next year. But how fast Greenspan should proceed is open to question.
Consider inflation. One of the great surprises of the current recovery is the surge in commodity prices, especially oil, thanks to China's growth and soaring demand for imports. Another surprise is the unexpectedly quick return of corporate pricing power. Government statistics may show that core inflation remains low, but people are paying more for milk, napkins, health care, houses, movies, and, of course, gas. The sudden wave of higher prices may ebb, but maybe not. If it continues, higher prices could lead to inflationary expectations, giving Greenspan reason to speed up the pace.
Nothing exemplifies the uncertainties Greenspan faces better than June 30, the second day the Fed meets. It's the same day the U.S. hands sovereignty over to the Iraqis and a reminder that the Middle East -- and al Qaeda -- remain treacherous geopolitical imponderables that could shock financial markets and hurt growth.
If the past is any prologue to Greenspan's behavior, the '90s show he would rather go slow now in tightening monetary policy. The reason is simple: productivity. Productivity is the key variable in determining the economy's speed, and Greenspan correctly foresaw that higher productivity allowed faster noninflationary growth. Record low unemployment and higher real wages resulted, but so did the tech boom and stock market bubble.
Productivity is growing today even faster than in the '90s, averaging an astonishing 4.5% annually since the beginning of 2001. But Greenspan doesn't know how long this can be sustained or how far it may fall. There also appears to be plenty of slack capacity left over from the bust, but, again, Greenspan doesn't know how much of it is obsolete. Even more worrisome, surging home prices, up 7.5% over the past year, may be a warning that a bubble in housing prices is developing. In the '90s, Greenspan made a decision not to try preventing a bubble but to manage problems resulting from it bursting. He may face that choice again.
Greenspan's term is up in 2006, after serving since 1987 as chairman. He'll need all his experience to guide America, and the world, through the unpredictable times ahead.