Fed chief defends handling of '90s bubble

Monday, January 5, 2004

WASHINGTON -- Federal Reserve chairman Alan Greenspan defended himself over the weekend against a criticism of his tenure, saying policy-makers would have damaged the economy in the late 1990s had they tried to burst that era's speculative stock market bubble.

"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," Greenspan said in a speech to the American Economic Association's annual meeting in San Diego. A copy of his remarks was distributed in Washington.

Greenspan previously has defended the Fed's handling of the high-flying stock market late in the Clinton administration. In his speech over the weekend, he said the Fed correctly focused policies on trying to mitigate probable damage from the eventual bursting of the bubble of stock market speculation.

"There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble's consequences, rather than the bubble itself, has been successful," Greenspan said. "Despite the stock market plunge, terrorist attacks, corporate scandals and wars in Afghanistan and Iraq, we experienced an exceptionally mild recession" in 2001.

Some critics have argued that the central bank made a major policy mistake by failing to curb stock prices as they soared. The bubble finally collapsed in the spring of 2000, wiping out trillions of dollars in paper wealth.

For the Fed to have influenced the level of stock prices significantly during the boom, Greenspan said, short-term interest rates would have had to have been ratcheted up high enough to risk severe damage to the economy.

'Applied our lessons well'

Greenspan did not address in his speech the future course of short-term interest rate policy or the direction of the U.S. economy.

"Essentially I think this speech says, 'We have learned much about monetary policy-making, and we have applied our lessons well,'" said economist Ken Mayland, president of ClearView Economics.

Greenspan, in answering questions after the speech, downplayed the potential risk of a new stock price bubble emerging now that the economy is getting stronger.

"My own sense is that we don't have to worry too much about the emergence of real bubbles again for a while because I think it takes a number of years for the trauma of the collapse to wear off," Greenspan said.

Amid signs the economy is gaining traction, economists believe Fed policy-makers will hold a key short-term rate at a 45-year low of 1 percent at their first meeting of this year on Jan. 27 and 28. Some analysts believe the Fed could begin to nudge rates upward as early as June. Others believe, however, that rates will stay where they are into 2005.

Many economists also believe the Fed's credit-easing campaign that started in January 2001 and saw the last cut in June 2003 probably has ended.

Greenspan said the Fed had been able to cut short-term rates so aggressively because inflation posed no threat to the economy. In fact, as the economy struggled to recover in the first half of last year, Fed policy-makers worried more about prices moving down, into deflation, rather than up, into inflation.

"We thought we needed to be, and could be, forceful in 2002 and 2003 as well because, with demand weak, inflation risks had become two-sided for the first time in 40 years," Greenspan said.

As he has in the past, Greenspan rejected the use of a device called "inflation rate targeting," which is used by some central banks. Using the tactic, a central bank sets an optimal target for inflation for the year, then manages interest rate policy to achieve that goal.

Greenspan said he preferred a more flexible approach to policy-making.

"Simple rules will be inadequate as either descriptions or prescriptions for policy," he said.

More communication

Separately, Fed policy-maker Ben Bernanke, in a Saturday speech to the same group, suggested some ways that the central bank might be able to improve the way it communicates with Wall Street and Main Street.

Bernanke suggested, among other things, that the Fed's economic forecasts be released more often than the current twice a year and minutes of the Fed's meetings be released quicker. The minutes are now released six to eight weeks after a meeting.

However, Bernanke didn't believe that televising the Fed's eight meetings a year on interest rate policy would be a good idea. Doing so, he said, would "risk comprising the integrity and quality of the policy-making process itself."

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