Did Fed Hit the Brakes Too Hard, Too Late?

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Did Fed Hit the Brakes Too Hard, Too Late?

Greenspan Defends Policy Against a Chorus of Criticism

By John M. Berry

Washington Post Staff Writer

Sunday, April 22, 2001; Page H01

Federal Reserve officials are no strangers to criticism. They've heard all the barbed complaints about how the central bank takes away the punch bowl just as the party gets going, and thousands of home builders once sent then-chairman Paul A. Volcker short pieces of lumber to protest the impact of high interest rates on their industry.

In more recent months, as the economy has stalled and the stock market has tumbled, letters have poured in to the Fed from individuals complaining bitterly that the central bank's actions over the past two years have ruined their retirements by driving down share prices. And even though the Fed has aggressively cut interest rates since the beginning of the year, many economists, politicians and business executives are complaining that it waited too long to begin lowering rates and that they are still too high.

Until parts of the stock market began to head south a year ago, Chairman Alan Greenspan and other Fed officials were being hailed as geniuses. The economic expansion that began in early 1991 had become the longest in American history, and in an unusual twist, non-inflationary growth had accelerated as the expansion aged. The growth of productivity -- the amount of goods and services produced for each hour worked -- appeared to have shifted into a higher gear, raising U.S. living standards in the process.

And the nation's unemployment rate was down to nearly 4 percent, a rate previously believed possible only in a world of increasing inflation. And that low rate meant that many Americans with fewer skills and low incomes were able to find jobs where none had been available before.

Then things began to sour.

The major stock indexes began slipping, and the nation's economic growth fell suddenly and sharply late last year to a 1 percent annual rate. It apparently hasn't done much better since.

While the Fed clearly sought to slow the nation's economic growth rate from an unsustainably high level, it clearly did not intend to cause growth to slow so much so fast, braking the economy to the point of possible recession.

All of which has prompted plenty of spirited second-guessing.

Too Slow to Act?

Some economists and Wall Street analysts argue that the Fed contributed to the overheating of the economy by leaving interest rates too low for too long after the autumn of 1998, when financial markets seized up amid financial crises in Russia and Asia. Fed policymakers quickly lowered their target for overnight interest rates by three-quarters of a percentage point, to 4.75 percent, and left it there until June 1999.

Before that worldwide market spasm, the Fed had been on the verge of raising rates because of fears that heady U.S. growth could spur inflation. These critics say the Fed should have started raising rates months before mid-1999, when it began lifting the target in a series of steps over the following year, to 6.5 percent by May 2000.

Once the Fed began raising rates, numerous other critics argued -- as some are still doing -- that higher rates weren't needed because inflation wasn't a problem. Still another group agrees that higher rates were called for but that the Fed overdid it, particularly with its final half-percentage-point increase last May. Some complain the Fed responded too slowly to signs of trouble by waiting until January of this year to begin cutting rates again, even though it has lowered the target to 4.5 percent since then.

Rising Criticism

Then there are those, like economist Stephen Roach of Morgan Stanley Dean Witter & Co., who believe Greenspan helped create some of the excesses of 1999 by stressing the glories of investment in high-tech equipment that could raise corporate profits and justify higher stock prices.

"By championing the brilliance of the new economy, Alan Greenspan joined with the . . . crowd in tacitly encouraging businesses and consumers to do the same. And they did," Roach told his firm's clients last week. "Companies became convinced that open-ended technology spending was the source of hyper-growth in both productivity and earnings.

"The financial bubble . . . truly infected the real economy. And the Fed did nothing to stop it," Roach said.

With U.S. economic growth limping along, unemployment rising, corporate profits falling and most stock prices well off their highs of a year ago, criticism is hardly surprising. But Greenspan and his Fed colleagues are unrepentant. They argue that in the summer of 1999 they had no choice but to clamp down on an economy gripped by a feverish boom.

Furthermore, some of the officials note, a large portion of the sharp run-up in stock prices, particularly for Internet and other high-tech companies, occurred months after the red flags of rising interest rates were flying. For instance, the tech-heavy Nasdaq composite index essentially doubled between the end of June 1999, when the Fed started to raise rates, and March 2000, when the index peaked.

Boom-Bust Issues

To some Fed officials, the investor behavior that relentlessly drove the Nasdaq ever higher in the face of rising interest rates is a prime example of the overheated nature of the U.S. economic environment that Fed officials felt they had to address. Left alone, the boom eventually would have turned into a bigger bust, with potentially far more serious consequences for the economy than those experienced so far, the officials say.

Not so, complains Richard M. Salsman, president of InterMarket Forecasting of Cambridge, Mass., who says the Fed "responded to prosperity by punishing it."

"Had Fed officials sat still," he said, "we'd still be enjoying solid growth with low inflation and rising stock prices."

Early last month at a House Budget Committee hearing, Rep. Gil Gutknecht (R-Minn.) more gently chided Greenspan, "Do you think that perhaps the Fed waited a little long to lower interest rates?"

"No," Greenspan replied. His explanation of that answer to Gutknecht and his comments elsewhere add up to the following:

Greenspan's Case

From the beginning of 1999 through last spring, the economy truly boomed. Consumer spending and business investment in new plants and equipment were increasing so fast that the economy grew in the second half of 1999 at a phenomenal 7 percent annual rate after adjustment for inflation. With the unemployment rate already falling toward 4 percent and business investment outstripping the amount of funds available to finance it, Fed officials were convinced that such unchecked growth would eventually lead to an inflation-induced bust.

One key piece of evidence of strain cited by the officials was the fact that long-term interest rates were already rising substantially before the Fed began to raise the short-term rates over which it has some control.

"The effect of that [surge in investment] was to put very significant [upward] pressure on real long-term interest rates, corporate interest rates," the Fed chairman told Gutknecht.

Under such circumstances, Greenspan said, the only way the Fed could have held down short-term rates was through "accelerating money-supply growth" -- that is, by pumping ever-greater amounts of money into an already overheating economy. Had the Fed chosen to do that, "we would have had a highly buoyant economy with rapidly increasing imbalances" between supply and demand both in financial markets and the real economy, he said.

If the Fed had kept short-term rates low, the country "conceivably" would have a higher level of economic activity now than it does, Greenspan continued, but that would have created "far greater imbalances" in the economy and eventually "a far greater correction than we're now undergoing."

And Greenspan concluded: "In my judgment, and the judgment of my colleagues, had we moved sooner [to lower rates], we would have threatened that adjustment process. It is a very difficult judgment to make, but in retrospect, I see nothing that we did which strikes me as inappropriate, as far as policy was concerned."

So far the "adjustment process" has meant slower growth of consumer spending; a slowly rising jobless rate with tens of thousands of layoffs, particularly at manufacturing firms; roughly a 10 percent drop in corporate earnings; and steep declines in business spending on new equipment.

Stock Questions

The greatest source of criticism, however, has focused on what some regard as the Fed's assault on the stock market. Greenspan and other Fed officials have gone to great lengths to try to convince everyone that they are not in the business of targeting a particular level of stock prices. Some analysts believe that the Fed's half-point rate cut Wednesday was timed to occur when stock prices were already rising so that no one could conclude the central bank was trying to put a floor under the market.

Of course, rising interest rates usually do depress stock prices, and in 1999 Fed officials made no bones about their concern that big market gains, by adding to household wealth, were giving an unwelcome boost to consumer spending in a booming economy.

Certainly all of the major stock indexes are well below the peaks of a year ago. But the indexes are not down as much as one might think compared with where they were June 30, 1999, when the Fed began raising rates: At Friday's close, the Nasdaq was down 18 percent, but the Standard & Poor's 500-stock index was off only 7.8 percent and the broadest available index, the Wilshire 5000, was virtually unchanged, down just 0.5 percent. The Dow Jones industrial average is 6.9 percent higher.

Some economists scoff at the notion that it was Fed policy changes that caused parts of the stock market to fall so sharply over the past year. Interest rate policy is only one of a host of factors influencing the U.S. economy and its financial markets, they say.

"The truth is that we never know why these bubbles burst," said Princeton University economist Alan Blinder, a former Fed vice chairman. "But bubbles always do burst. Sometimes some not-crucial event can cause a bubble to burst and then it feeds on itself. Take Wile E. Coyote [in the Road Runner cartoons]. Why did he fall at just that time? Maybe he looked down and heard Alan Greenspan's voice."

"The Nasdaq fell 60 percent from the peak. There's no way you can get that from interest rates. Higher interest rates should reduce stock prices on a fundamental basis, but that can't come anywhere near explaining the market decline and the timing puzzle" of the bubble still inflating after rates began to rise, Blinder said.

With the benefit of hindsight, one can argue that the Fed should not have raised rates as much as it did, Blinder agreed.

"But they stopped in May 2000, which was pretty early," he said. "It was not obvious in May of 2000 that the second half of 2000 and the first half of 2001 were going to look as they have turned out" with such a sharp slowing of economic growth. Moreover, even as late as November, "the economy was still looking very strong but the Fed was holding its fire" on further rate increases.

"The criticism that the Fed overstayed its tightening, while true, is very much Monday-morning quarterbacking," he concluded.

Faulty Forecasts

Blinder's comments highlight one of the Fed's frequent frustrations: Even significant shifts in the course of the economy take time to show up in the statistics. As late as mid-November, Clinton administration economists agreed on a short-term economic forecast covering the end of last year and 2001 and 2002 that failed to pick up the sharp weakening of the economy happening at that moment. Few private forecasters did either.

In addition, Fed officials, and many other forecasters, had been surprised in previous years when growth started to slow, only to pick up again in a burst of renewed activity.

"We've got a slowdown, and a lot of people are quite nervous," Fed governor Edward M. Kelley Jr. said in an interview at the end of November. "That's quite predictable. . . . But it's far too early to make a judgment on where the slowdown might stop. If we had a touch-and-go and went back up to high rates of growth, that would be dangerous."

Other officials feared that a rush to cut rates might encourage businesses and investors to think the necessary slowdown was never really going to come.

Brookings Institution economist Charles L. Schultze, who has been both a government policymaker and an observer of the process for many years, said Fed critics should take a step back and review not just the past few months but also the past few years.

"So much of the criticism is from hindsight, and it misses some points," Schultze said. "We didn't know it, but the world was changing in the late '90s so that we could get to 4 percent unemployment and 2 percent inflation. But the Fed was probing as it went, and there isn't any other central bank in the world that would have had that much moxie. Greenspan handled it awfully well."

The fact that the Fed earlier had established its credibility as an inflation fighter helped, "but a lot more was going on," such as the increase in investment and productivity growth, Schultze said.

"In 1994-95, the Fed also pushed rates up a lot, and it was true that first half of 1995 growth was only about 1 percent, but then it picked up again. Greenspan handled it right and kept the economy on an even keel.

"Now people are saying that he overdid the ease in 1998 . . ., but rates on neither corporate bonds nor mortgages came down a lot. It was not as if he gave us a period of low interest rates across the board," only lower short-term rates, he said.

"Finally, in the 10th year of recovery, you got this wild behavior by the Nasdaq and the Fed had to navigate its way through it. And except for the stock market, after 10 years of expansion and tight labor markets and all that, we don't seem to have a whole lot of financial excesses. It isn't like 1988-89," when the commercial real estate market was collapsing and taking major financial institutions with it.

"I don't want to be a Pollyanna, because there are problems in this transition," Schultze concluded. "But the problems are not really terrible. It is hard to sort out who gets credit, but Greenspan certainly should not get any blame on it."

The R-Word

Meanwhile, the Fed has cut rates this year in its most aggressive manner since the second half of 1982 when the economy was in the depths of the worst recession since the Great Depression. Furthermore, Fed policymakers indicated more cuts are likely, including either a quarter- or a half-point cut at their next meeting, May 15.

"Right now we're worried about whether we're on the edge of something that starts with R, which I can't under these circumstances name," Robert McTeer, president of the Dallas Federal Reserve Bank, said in a speech Friday, alluding to the possibility of a recession. "We've got to put our concerns about inflation on the back burner and save the economy from the R-word."

A day earlier, Fed Vice Chairman Roger Ferguson sounded a similar note, though in more moderate tones.

"I think it's too early to have a strong conviction that the economy is reaching the end of this period of quite slow growth," Ferguson said. Just how low interest rates will have to go to spark "a return to healthy growth in spending remains an open question," he said.

Bruce Steinberg, chief economist at Merrill Lynch & Co., agreed with the two Fed officials' implicit point that rates need to go lower in coming months. If the Fed does continue cutting, he predicted, economic growth will pick up noticeably by the fourth quarter.

As for stocks, Steinberg pointed to history. Over the past 43 years, the Fed has cut rates as much as it has this year on 10 occasions. In each case, stock prices have been higher a year later. The increases have ranged from a meager 4.3 percent in 1968 to 57 percent in 1983, with an average of 25 percent.

© 2001 The Washington Post Company

-- (M@rket.trends), April 22, 2001

Answers

What a bunch of spineless crybabies. I think Greenspan should set the interest rate at 5% and never change it. Let these greedy yuppies find someone else to whine about. God forbid, they might discover that their losses were a result of their own stupidity. No, they'd never admit that.

-- conservatives are worthless shits (moreinterpretation@ugly.com), April 22, 2001.

conservatives are worthless shits,

LOL!

You have the gall to say that the losses of "greedy yuppies" were caused by "their own stupidity", and yet, regarding economics, your post shows a level of stupidity that is truly incredible.

You are obviously a moron when it comes to economics. But no, you would never admit that.

LOL!

-- J (Y2J@home.comm), April 23, 2001.

LMAO!

It's so easy to get your goat J! I see you like my name. I said nothing about economics, yet you pretend that you are so much wiser.

It's easy to see that you are very pissed off! ROTFLMAO!!

-- conservatives are worthless shits (and J is the @ leader. of the pack), April 23, 2001.


worthless shit,

You have neither gotten my goat nor pissed me off, but you have greatly entertained me. The greatest amusement, of course, is that you are so stupid that you don't even realize how stupid you really are.

In your latest post, you said, "I said nothing about economics, yet you pretend that you are so much wiser". Yet before, you posted this economic gem, "I think Greenspan should set the interest rate at 5% and never change it".

You see, my little moronic chum, whether you realize it or not, when Alan Greenspan and the Fed set interest rates, this is part of the grand scheme of things that are considered economics. Your imbecilic comment that "Greenspan should set the interest rate at 5% and never change it", clearly shows that in the area of economics, you are just plain dumb.

Please explain to the forum how an unchanging 5% interest rate would work in a modern complex economy like that of the United States. It will be great fun to see your attempt at an explanation. LOL!

No pretending is needed, when it comes to economics (and probably most other things, as well), I am much wiser than you are.

-- J (Y2J@home.comm), April 23, 2001.

Duuuh dumbfuck! I know how the interest rate works and am much wiser than a dumbfuck like you who probably put all his money in tech stocks with the rest of the stupid yuppies.

You got what you deserve for being so greedy. ROTFLMAO!!!

-- conservatives are worthless shits (their greed will never @ allow them. to be content), April 23, 2001.



worthless shit,

Nice comeback. LOL!

You are clearly one of, if not the, stupidest posters ever to disgrace this board. My guess is that you are a child, but the sad fact may be that you are actually an adult.

Since you claim to be so wise about economics, especially "how the interest rate works", please expound to the forum exactly how an unchanging 5% interest rate would work in a modern complex economy like that of the United States.

-- J (Y2J@home.comm), April 23, 2001.

J,

It is not obvious that monetary policy has been overly effective the past five years. Some would argue that a constant rate would have been better than the curent zig-zag course and its related asset inflation. If you want sources, may I suggest one of the gold forums or the prudent bear?

-- FedUp (AsGood@sAnyoneElses.com), April 23, 2001.


FedUp,

I agree that monetary policy is not always effective. It is a complex situation that I would be glad to discuss with you at some point in the future. However, I don't want to do it right at this moment, because I am convinced that the poster known as, "worthless shit", doesn't have a clue about that which he speaks.

For us to openly discuss the complexities of monetary policy would give the little cretin information that I am convinced he doesn't have. In fact, I believe that his failure to reply to my question is because he has absolutely no idea what to say.

-- J (Y2J@home.comm), April 23, 2001.

J:

Don't be silly. He's obviously capable of replying without any earthly idea about anything.

-- Flint (flintc@mindspring.com), April 23, 2001.


J is even dumber than I thought he was. He obviously couldn't wait to jump on an opportunity to pretend that he is somehow intellectually superior, much the same way that Flint and Z always do.

The context of my statement was that Greenspan should not change the rate just to piss off the whining greedy yuppies who keep blaming him for their own lack of knowledge and experience. The interest rate is used to control the money supply in our economy. Unfortunately lately it has been used as a tool to control the emotional behavior of the stock markets, something which should have been left to take its own course. If Greenspan would quit using it to keep these fools in check, they would have to take responsibility for their own actions instead of crying about him.

-- conservatives are worthless shits (moreinterpretation@ugly.com), April 23, 2001.



J:

See what I mean?

-- Flint (flintc@mindspring.com), April 23, 2001.


worthless shit,

I am intellectually superior to you.

Earlier you said that, "I said nothing about economics". Now you concede that, "The context of my statement was that Greenspan should not change the rate just to piss off the whining greedy yuppies who keep blaming him"...

Talking yourself in circles now, aren't you boy?

Judging roughly by your latest post, I would guess that you have a very small understanding of economics in general, and of monetary policy in particular. Of course, the fact that you write like a twelve year old makes analyzing your level of knowledge very difficult. I am sure that it was, for you, a nice try. I commend you for that.



Flint,

You are dead on regarding this one.

-- J (Y2J@home.comm), April 24, 2001.

It was a JOKE, dumbass! GET IT??? I don't seriously think he should keep the interest rate steady, you dumbshit. Gaaaawd, are you dense! Believe me, I know a fuck of a lot more about economics than you, and a fuck of a lot more about everything. I don't need to go around butting in on other people's jokes to start a debate and try to show how intelligent I am, like you and your fellow anthill kickers Flint and Z. That is the sign of a very insecure ego, and an inferiority complex. Then again, it's natural that you should feel inferior, you are a dim-witted conservative. LOL.

-- conservatives are worthless shits (and dumber than @ a horse's. ass), April 24, 2001.

worthless shit,

So it was a joke, huh? Kind of like when you were threatening the President? I don't think that the Secret Service will find that one to be very funny.

I didn't find your joke to be funny, either. I did find your comment, "Believe me, I know a fuck of a lot more about economics than you, and a fuck of a lot more about everything", to be hilariously funny. It's as if you are claiming to be an economic genius, and yet you speak like Tony Soprano. LOL!

-- J (Y2J@home.comm), April 24, 2001.

Je-e-ee-ezzz J, I'm sh-sh-shakin in my boots. Sniff-snifff, sob-sob, I'm scared! Please, please, call off the jack-booted thugs!

Oh, if they must come over, please, please, tell them I'll be VERY nice. I even have some friends for them to meet... Mr. Smith, Mr. Wesson, Mr. Winchester, and Mr. Mossberg.

Sob, sob, I'm shakin, boo-hoo-hoo.

-- conservatives are worthless shits (and J is the @ dumbest of. them all (lol)), April 24, 2001.



worthless shit,

This I would love to see!

I tell you what, worthless shit. The Secret Service will most likely find you through the ISP information that you left on this website, but it will take time. To speed things up, why don't you just tell me where to direct them?

Unless, of course, you really are scared.

-- J (Y2J@home.comm), April 24, 2001.

Again, LMAO.

Either I've been away too long or I am just easy to amuse today.

These threads are too funny, btw, Dude, did you threaten the pres? I never read that, I read somethin else, but J, can you give us the exact link and wording, um, if you will.

Why? Because I dont think that is what he/she said.

-- sumer (shh@aol.con), April 25, 2001.


sumer,

How have you been? It seemed that you were gone for a spell; it is good to have you back.

On Little Nipper's "Presidential selection took the heart out of democracy" thread, worthless shit said, "Hmmm, guess we'll have to build up our arsenals so that Dumbya will be too dead to steal the office again next time". There is more after that.

I would link to the thread for you, but it is late, and I am just too tired to do it right now. If you scroll down the new answers, you should be able to find it fairly easily.

-- J (Y2J@home.comm), April 26, 2001.

Who's "Dumbya"? How do you consider that a threat to the president, Dennis you dumbass?

You can make all kinds of accusations, but they aren't true unless you can prove it. I think you've been listening to too much Rush Limbaugh and you don't know the difference between entertainment and reality.

-- (get a grip J @ aka paranoid. Dennis Olson), April 26, 2001.


I wonder if the anonymous poster is our little chum, starting to get a little worried? The reasoning skills are about the same. LOL.

You see, anonymous coward, I don't have to prove anything for it to be true. I have sent the evidence along to the Secret Service, and they will decide if the words constitute a threat to the life of the President, or not. If they decide that the words do, then it is true.

Period.

-- J (Y2J@home.comm), April 26, 2001.

Sheesh J, you are a disgrace to conservatives. You sent a letter to the Secret Service telling them someone threatened to kill Dumbya? I don't think they are going to appreciate you referring to the president as Dumbya. That's kind of like going up to a Nazi goonand calling Hitler an idiot, you could be executed for saying such things. You sound more like a whining liberal to me, please don't associate yourself with the Conservative Party from now on.

-- Rush Limbaugh (J is @ traitor. to conservatives), April 26, 2001.

I hate to ruin your witch hunt J, but that is really a stretch. Aren't you worried that the SS might think you are some kind of fruit loop? Did you sign the letter?

First you would have to admit that President Bush is Dumbya, then you would have to admit that he stole the presidency. I don't think the SS is going to take your story too seriously, in fact they'll probaly get a lot of laughs from it.

-- Not A Believer (in@paranoid.conspiracies), April 26, 2001.


Rush Limbaugh,

You don't sound at all like the Rush Limbaugh that I know. Instead, you use the same tired argument that worthless shit did on the other thread. I wonder why that is? LOL.

Once again for the hard of thinking, "Nazi goon squad" and "Dumbya" are the terms used by worthless shit. I used them only when quoting him. If you think that line of reasoning is going to confuse the Secret Service, then you are incredibly stupid, incredibly desperate, or both.

-- J (Y2J@home.comm), April 26, 2001.

Not A Believer,

I don't really care what some anonymous poster thinks, but thanks for playing.

-- J (Y2J@home.comm), April 26, 2001.

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