- The Washington Times - Friday, August 29, 2003

JACKSON, Wyo.(AP) — Alan Greenspan yesterday mounted a strong defense of his handling of monetary policy against criticism that the Federal Reserve Board has unnecessarily confused financial markets recently with its mixed signals on interest rates.

Mr. Greenspan, entering his 17th year as chairman of the Fed, used an appearance before a prestigious monetary conference to defend his legacy against the recent attacks and an old but persistent complaint that his biggest error was waiting too long to prick the stock market bubble of the late 1990s.

The participants at this year’s conference, which included central bankers from around the world, held a spirited, if at times highly technical, debate on such subjects as the benefits of using inflation rate targeting to provide better guidance to markets. Under this system, a central bank would announce an annual target for inflation and then conduct monetary policy to achieve that desired level of price increases.

Mr. Greenspan has argued that setting a numerical target is too inflexible and simplistic when the U.S. central bank is faced with an enormous array of variables in trying to manage the U.S. economy.

He said that policy-makers must manage monetary policy in a world of uncertainty, ready at all times to deal with a wide variety of risks, including some that seem very remote.

“Some critics have argued that such an approach to policy is too undisciplined, judgmental, seemingly discretionary and difficult to explain,” Mr. Greenspan said.

But he said that rules, such as establishing a target for inflation, are “by their nature simple” and a poor substitute for discretion on the part of policy-makers trying to manage a wide variety of risks in a complex economy.

Mr. Greenspan said it was sometimes necessary for the Fed to take out an insurance policy “against the emergence of especially adverse outcomes.”

As an example, he said the Fed needed to be alert to the remote possibility that the country could be faced with a bout of deflation, or a sustained decline in prices, something that has not occurred in the United States since the Great Depression of the 1930s.

Mr. Greenspan and his colleagues have been criticized for sending misleading signals to financial markets beginning in May with their comments on deflation, triggering a roller-coaster ride in the bond market. This sent long-term interest rates falling to the lowest levels in more than four decades, only to backtrack with a sharp rise in rates in recent weeks.

The rise in interest rates began after the Fed at its June meeting disappointed investors by cutting a key short-term interest rate by only a quarter-point, instead of a hoped-for half-point, and made no mention of unconventional methods to lower interest rates further.

Interest rates on 30-year mortgages, which had fallen to a low of 5.21 percent in mid-June, have jumped by more than a percentage point since that time, to 6.32 percent currently.

Mr. Greenspan did not specifically address the roller-coaster ride the bond market has been on recently, but analysts viewed his overall comments as a further commitment to keep the federal funds rate, now at a 45-year low of 1 percent, at that level for many more months to try to moderate the surge in long-term interest rates.

As a comparison to the recent worries about the remote possibility of deflation, Mr. Greenspan pointed to the Fed’s actions at the height of the Asian and Russian financial crisis in 1998 when the Fed moved aggressively to cut interest rates to keep global turmoil from derailing the U.S. economy.

“The product of a low-probability event and a severe outcome, should it occur, was judged a larger threat than the possible adverse consequences of insurance that might prove unnecessary,” he said.

One of the papers at this year’s conference, prepared by economists at the Bank for International Settlements in Switzerland, reopened the argument over whether the Fed erred when it did not move to raise interest rates more quickly in 1999 to keep a stock market bubble from expanding further.

Stock prices eventually peaked in the spring of 2000 and since that time trillions of dollars in paper wealth have been wiped out.

Mr. Greenspan said his views had not changed from those he expressed at last year’s conference — that small increases in interest rates would not have pricked the bubble and that massive rate increases would have pushed the country into a recession.

“We know that if we raised interest rates by [10 percentage points] we will knock down any asset bubble, but we will also knock down the economy,” he said.

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