Monday, November 20, 2006

Geenspan's Legacy?

By Caroline Baum

Nov. 20 (Bloomberg) -- Alan Greenspan didn't go quietly from the global stage when he retired as chairman of the Federal Reserve in January. His speeches are still widely reported, his economic views and forecasts instantly disseminated.

It would probably be better if they weren't.

His latest ``forecast'' -- that the worst of the housing slump is over -- was rudely challenged Friday when the Commerce Department said October housing starts plunged 14.6 percent from the prior month to a six-year low. Starts were down 27.4 percent in October from a year earlier; single-family starts have fallen by more than a third since the start of the year. Housing permits declined for the ninth consecutive month, a record.

Having presided over the late 1990s stock-market bubble, and having cut interest rates aggressively to clean up the mess when it burst, Greenspan has a vested interest in the health of the housing market. If the residential real-estate boom ends badly, as all bubbles do, he could go down in history as a ``DBCB,'' or double-bubble central banker.

No wonder Greenspan is laying out a new framework for analyzing the once-soaring property market. In a speech to a private group in Canada last month, Greenspan said the housing boom wasn't a response to the ``1 percent fed funds rate or from the Fed's easing. It came from the collapse of the Berlin Wall.''

Let's just say it's good he's writing his own life story. His economic theories might not stand up under objective analysis.

Guilty as Charged

As for his legacy, the early assessment of Greenspan's role in recent asset bubbles isn't exactly exculpatory, according to economists who participated in the Cato Institute's 24th Annual Monetary Conference, ``Federal Reserve Policy in the Face of Crises,'' on Nov. 16.

``Among the consequences of the policy of maintaining interest rates at an inappropriate low level were credit and mortgage-market distortions, discouragement of personal savings, incipient inflation, and depreciation of the dollar foreign exchange rate,'' said economist Anna Schwartz.

Schwartz, who co-authored ``A Monetary History of the United States, 1867-1960,'' with the late Nobel Laureate Milton Friedman, was referring to the Fed's decision to leave the funds rate at 1 percent from July 2003 to June 2004, ``a policy unjustified in view of the economy's growth rate,'' and to raise it ever so slowly during the next two years.

Had the Fed been forward looking, it would have heeded the signs from leading indicators -- the yield curve was steep and getting steeper -- which had turned a solid green. Instead, policy markers were fretting over deflation, or a decline in the price level, just as the economy was taking off.

History Repeats

It makes you wonder if the Fed's harping on inflation risks right now won't, in retrospect, seem equally misplaced.

On the subject of the Fed's timing at turning points, don't forget policy makers had a bias to raise rates in November 2000, a quarter sandwiched between two in which the economy contracted. The Nasdaq Composite Index was already down 40 percent from its March high. I can only imagine the discussion at the time -- something like: ``The effects of such a huge loss of wealth are likely to be contained.'' (Sound familiar?)

Needless to say, no one at the Cato conference concurred with Greenspan's Fallen Walls Doctrine as the reason for the speculative housing boom over the last five years. Most of them advocated a do-nothing policy for the Fed in the face of fiscal crises, but as Harvard University's Jeffrey Frankel admitted, ``there are no libertarians in crises.''

Nothing makes a central banker -- even the most ardent Ayn Rand advocate like Greenspan -- hit the ``print money'' button as quickly as the hint of ``systemic risk.''


``Did the Greenspan Fed err by providing too much liquidity in 2001-2004?'' Frankel said. ``My answer is `probably yes.' I await Woodward's customary follow-up book.'' (Perhaps ``Plan of Attack'' is to ``State of Denial'' as ``Maestro'' is to ``Rookie?'')

Cato Chairman William Niskanen was no more complimentary of Greenspan's crisis management (no mention of risk management).

``Ben Bernanke's next major challenge will be to avoid the recession that may be a consequence of deflating the demand bubble that he inherited from Alan Greenspan,'' Niskanen said. The record of the past 20 years suggests the Fed's overreaction to financial crises raises the probability of recession, imposing a ``long-term cost'' on the economy.

The fourth panelist to address the role of the Fed in financial crises was St. Louis Fed President Bill Poole, who advocated prevention as the best medicine. By promoting ``price stability and general macroeconomic stability,'' the Fed can ``reduce the likelihood of conditions that would be conducive to financial instability,'' he said.

Big Question Mark

Poole, who has been on the Fed's policy-setting open market committee since 1998, obviously had nothing to say on the subject of Greenspan's legacy.

Legacies come in all shapes and sizes. Public servants would like to be remembered for their own good deeds, as well as their contribution to the institution they serve.

On the latter count, Greenspan comes up way short, according to Lawrence Wright, professor of economic history at the University of Missouri, St. Louis.

``At his confirmation hearing, Ben Bernanke told the Senate Banking Committee: `With respect to monetary policy, I will make continuity with the policies and policy strategies of the Greenspan Fed a top priority,''' Wright said. ``No doubt Bernanke meant to reassure us. Unfortunately, we never knew what Greenspan's policy strategy was.''

With each passing day, it's becoming increasingly clear.

(Commentary. Caroline Baum, author of ``Just What I Said,'' is a columnist for Bloomberg News. The opinions expressed are her own.)

To contact the writer of this column: Caroline Baum in New York at .

Friday, November 10, 2006

Helicopter Ben not interested in money supply! (Financial Times)

Trichet and Bernanke differ on strategy
By Ralph Atkins in Frankfurt
Published: November 10 2006 18:44 | Last updated: November 10 2006 18:44
Transatlantic differences over monetary strategy erupted into the open on Friday as the European Central Bank sought to modernise its policy of relying on money supply measures as an inflation early-warning system.

Jean-Claude Trichet, ECB president, used a Frankfurt conference to stress the importance of indicators such as M3, the broad money supply measure.

But in contrast, Ben Bernanke, US Federal Reserve chairman, said a heavy reliance on money supply measures “would seem to be unwise in the US context,” although money growth data might still offer important signals about future economic developments.

Mr Trichet refused to comment on whether differences between the US and European economies justified a different approach to the use of money supply data. But he acknowledged the need for monetary analysis to become more sophisticated, taking into account financial innovation.

Lucas Papademos, ECB vice-president, signalled that at least some on the bank’s governing council would like to merge the monetary component and the ECB’s more general economic analysis into a single “fat pillar” of analysis and revealed that preliminary work that could lead to such a project was already under way at the ECB. “But this will be a larger pillar in which money will continue to play a prominent role in guiding our monetary policy decision making,” he said.

The ECB’s “monetary pillar,” largely inherited from Germany’s Bundesbank, is controversial among economists because of confusion about the implications of money supply for inflation. At the ECB-hosted conference, prominent officials from the Frankfurt institution made clear that they saw significant scope for refinements. Recent fast growth in M3 and in credit figures has encouraged speculation that the ECB will continue lifting interest rates further in 2007, after an expected quarter percentage point rise in its main rate to 3.5 per cent in December, even though inflation is currently within the central bank’s definition of price stability – a rate “below but close” to 2 per cent.

ECB research presented at the conference was open about the shortcomings of the bank’s monetary analysis in its eight-year history.

Mr Trichet said the monetary analysis had been instrumental in the ECB’s decision to start raising interest rates in December 2005. At the time many economists and politicians feared its actions were premature given the uncertainties then about the eurozone’s economic outlook. “Without our thorough monetary analysis, we could have been in danger of falling behind the curve,” he said.

Mr Bernanke pointed to larger methodological problems in the US. “The rapid pace of financial innovation in the US has been an important reason for the instability of the relationships between monetary aggregates and other macroeconomic variables.”

Changes in payment technologies and individuals’ behaviour had meant usage of different kinds of accounts “have at times shifted rapidly and unpredictably”.