- The Washington Times - Tuesday, May 29, 2007

Federal Reserve Chairman Ben S. Bernanke is discovering one of the many challenges facing a new central bank chief: dealing with the market-rattling pronouncements of his still popular and revered predecessor.

Former Chairman Alan Greenspan has moved global markets in recent months with his assessments of the likelihood of recession in the United States and the fallout from the U.S. housing and subprime mortgage collapse. Earlier this month, Mr. Greenspan helped spur a 100-point jump in the Dow Jones Industrial Average by noting that the odds are 2-1 against a recession this year.

Ironically, the financial oracle was simply stating the inverse of a prediction he made in March that sent global markets nose-diving: that the economy had a 1 in 3 chance of recession.

Fickle markets apparently liked the ring of optimism and reacted when he restated the odds.

Shortly after helping stoke a record high for the Dow, Mr. Greenspan told a Georgia audience that “the markets go berserk” so he is trying to be more careful about his public comments. But within days, he shook global markets again by warning that the soaring Chinese stock market could undergo a “dramatic contraction.”

Mr. Greenspan’s comments have provoked consternation and outrage in some financial circles. Bank of England Governor Mervyn King told reporters he is “very grateful” that his predecessor, Edward George, since retiring in 2003 has “not been in the newspapers or on the radio all the time commenting.”

John Makin, an economist with the American Enterprise Institute, said Mr. Greenspan’s comments in March about a recession provoked “dismay and amazement” and were “awkward” and “discomforting” to Mr. Bernanke. The Fed was not prepared to concede a risk of recession and instead was striving to convince financial markets that it was steadfastly focused on eliminating the risk of inflation.

Mr. Bernanke has seemed unperturbed by his predecessor’s pronouncements. He even defended Mr. Greenspan’s right to earn a living making speeches and offering advice after 18 years on a relatively modest salary at the Fed.

Since January 2006, Mr. Greenspan has been lecturing around the world and writing a book, “The Age of Turbulence,” to be released in September. He recently announced that he would advise the Pimco bond funds, in his first formal role since leaving the Fed.

Mr. Bernanke, who declined through a spokesman to be interviewed for this article, has dissented from Mr. Greenspan’s characterization of an aging economic expansion that is in danger of falling into recession.

“There seems to be a sense that expansions die of old age, that after they reach a certain point, then they naturally begin to end. I don’t think the evidence really supports that,” he said in March testimony before the Joint Economic Committee. “If we look at history, we see that the periods of expansions have varied considerably. Some have been quite long. And the evidence that expansions must ultimately come to an end essentially of old age does not seem to be there. So our basic forecast remains for moderate growth and that’s our expectation.”

The disagreement between the two economic titans is not trivial, and only one can be right. But from the point of view of the economy, only one opinion matters: Mr. Bernanke’s. If he is wrong, the U.S. and world economies will pay the price. Despite the occasional tip of the hat to Mr. Greenspan, it is Mr. Bernanke’s views that carry the most weight in financial markets.

The Fed’s actions can make or break the U.S. economy, and whatever happens to the world’s largest economy reverberates to the far corners of the globe that rely on U.S. markets.

The head of the U.S. central bank is the most powerful financial player in the world, and his words inevitably move markets. When the Fed raises interest rates, that raises the cost of buying homes, financing education, and starting and expanding businesses around the world.

With economic growth early this year slowing nearly to a stall in the United States, many Wall Street economists say the Fed needs to cut interest rates to revive economic growth. Some fear that the Fed could sink the economy into recession if it does not relent in lowering the core rate of inflation, currently at about 2.25 percent, back into the central bank’s “comfort zone” between 1 percent and 2 percent.

“The Fed’s current obsession with the 1 percent to 2 percent range is not a matter of economics, but of religion,” said Paul McCulley, investment strategist at the Pimco funds where Mr. Greenspan is now employed. He warned of “negative macroeconomic effects” if Mr. Bernanke keeps rates too high for too long in a quixotic effort to minimize inflation.

Pimco is one of the most influential bond funds in the world. Its leaders play a role in setting the level of long-term interest rates in the bond markets. Their opinions are important to the Fed, because long-term interest rates play a critical role in spurring growth in the housing market and other areas of the economy. The Fed controls short-term interest rates, but controls long-term rates only through exerting influence over the bond market.

Speaking to the stock, bond and dollar markets — and prodding them from time to time when it suits the Fed’s purposes — is an important part of the Fed chairman’s job. It is a skill that Mr. Bernanke, as an academic economist for much of his career, had limited opportunities to develop and polish. Mr. Greenspan, a Wall Street economist both before and after his Fed tour, is an acknowledged master.

Mr. Bernanke made a misstep when he first took over as chairman, making an offhand remark to a reporter that sent a tremor through the markets. Afterward, he has stayed consistently on message and won high marks from Fed watchers for his overall handling of the markets.

Innate skill enabled Mr. Greenspan to develop a well-tuned relationship with the world’s financial markets during his tenure, but even he got upstaged a few times by his renowned predecessor, Paul Volcker, after taking office in 1987. Moreover, Mr. Greenspan had to face a major financial crisis in his first few months at the Fed: the October 1987 stock market crash, which immediately put his skills to the test.

Mr. Volcker had a towering reputation as the only Fed chairman in American history to conquer double-digit inflation, perhaps the top distinction for any central banker. Like Mr. Greenspan, his views are still sought out by investors, legislators, businessmen and universities around the world.

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