- The Washington Times - Tuesday, January 6, 2004

Federal Reserve Chairman Alan Greenspan delivered an insightful retrospective speech over the weekend about monetary policy during the past 15 years. Mr. Greenspan, who has served as Fed chairman since the summer of 1987, began by offering his comments “from the perspective of someone who has been in the policy trenches” and closed by noting that a review of the transcripts of Fed policy meetings would confirm that “making monetary policy is an especially humbling activity.” In between, he delivered a remarkable lecture about risk management in a world of increasing uncertainty.

Tossing aside his propensity for speaking in riddles, the Fed chairman stated, “The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble while preserving economic stability is almost surely an illusion.” Contrary to the claims of his critics, he asserted, “It is far from obvious that bubbles, even if identified early, can be pre-empted at lower cost than a substantial economic contraction and possible financial destabilization — the very outcomes we would be seeking to avoid.”

Mr. Greenspan marshaled much evidence to make his point. He cited the aftermath of two 12-month periods (one ending February 1989 and the other concluding February 1995), during each of which the Fed increased its target short-term interest rate by at least 3 percentage points. “In fact, our experience over the past two decades suggests that a moderate monetary tightening that deflates stock prices without substantial effect on economic activity has often been associated with subsequent increases in the level of stock prices,” he said. That was clearly the case following both tightenings noted above. Even the 1.75 percentage-point increase in the target rate from mid-1999 to May 2000 did little to deter the advance of stock prices. Indeed, the broad-based S&P; 500 stock index closed at 1,350 on June 29, 1999 (the day before the Fed began tightening). On May 16, 2000 (the day the Fed completed its cumulative 1.75 percentage-point increase in interest rates), the S&P; 500 closed at 1,466. Four months later, on Sept. 15, 2000, the S&P; 500 closed again at 1,466. Thus, it seems reasonable to conclude that only massive increases in short-term interest rates undertaken long before mid-1999 would likely have deflated stock prices. Surely, such a policy would have precipitated a major U.S. economic contraction — one, by the way, that probably would have had worldwide ramifications because that was the same period when much of Asia was already collapsing and Russia was defaulting.

In 1987, Mr. Greenspan took command of the Fed in the middle of what would eventually become the nation’s longest peacetime expansion — up to that point in time. To achieve that distinction, however, he and his colleagues had to successfully address the stock market crash of October 1987. After one of the mildest and shortest recessions (July 1990 to March 1991), Mr. Greenspan was largely responsible for engineering what proved to be the longest economic expansion in the 150 years for which there are official economic records. That was followed in 2001 by another eight-month-long, relatively mild recession.

The current recovery has steadily occurred (1) in the face of the aftermath of the worst terrorist attack in history; (2) amid a major corporate-governance scandal, whose origins developed and simmered during the second half of the 1990s; and (3) following a stock-market collapse, whose economic effects have surely been mitigated by the Fed’s aggressive policy actions. Meanwhile, the Fed has achieved what it has long sought: effective price stability.

Notwithstanding Mr. Greenspan’s admitted “humbling” experience at the Fed, he is certainly right to conclude that “monetary policy has meaningfully contributed to the impressive performance of our economy in recent decades.” The nation — and the world — owe a great debt to that policy.

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