The Fed chairman's description of the 'soft patch' in the US economy fails to address its need for a short-term stimulus
When Alan Greenspan accepted an invitation to testify before the Joint Economic Committee of Congress, the buzz was that the Federal Reserve chairman had something to say.
Maybe Greenspan would explain the bigger-than-expected 50 basis-point rate cut? Perhaps he would reconcile the aggressive rate action with the statement saying the risks to the economy were now balanced, even as the 1.25% overnight benchmark rate told a different story?
Greenspan did neither. He gave a terse historical recap on the state of the economy, citing the better-than-expected 3% growth over the past four quarters as a sign of the economy's resilience following the 11 September terrorist attacks. He delineated the importance of cash-out mortgages, extracting equity from a home, on consumer spending. And he talked about the forces constraining business investment, including excess capacity, declining stock prices, corporate-accounting scandals and 'heightened geopolitical risks''.
So what new information or intelligence did Greenspan have to offer? Let's just say when the Fed chief is reduced to reading verbatim the prepared statement issued after the meeting, it's time for a new staff of writers.
Of course, most of the time when the monetary authority treks up to Capitol Hill to testify, the senators and congressmen are more interested in what he has to say about fiscal policy.
Recall that Greenspan was the Democrats' favourite witness during the Clinton administration. Reducing the budget deficit was his number one priority; tax cuts and increased government spending were numbers two and three, in that order.
Less than a week after George Bush took office in January 2001, Greenspan was transformed into an advocate for a big tax cut. Any failure by Congress to cut taxes, in fact, would put the US government in the untenable position of having to buy securities of publicly traded companies.
With the federal government running surpluses since 1998 and paying down debt, Greenspan was afraid there would be no Treasury securities, the Fed's normal instrument for adding reserves to the banking system, left to buy.
Talk about a contrarian indicator. Fiscal 2001 was the last year of surpluses before the budget went back into deficit ($159bn) in fiscal 2002, which ended on 30 September.
The Democrats on the JEC were quick to get to the heart of their inquiry: tax cuts in a rising deficit environment. It was Greenspan the fiscal hawk who showed up, advocating a return to 'discretionary caps and pay-go rules and structure,'' which were central to the budget discipline in the early 1990s.
As deficits gave way to surpluses, spending caps were regularly circumvented by 'emergency spending''. Unless Congress returns to some self-imposed rules and triggers to contain the growing budget gap, it will be very difficult to ascertain what the implications of those actions, tax and spending initiatives, are over the long term, Greenspan said.
On the question of how best to stimulate spending, Senator Jack Reed, Democrat of Rhode Island, didn't get the answer he was looking for. He questioned the efficacy of making the tax cut permanent since high-income savers, not low-income spenders, would be the primary beneficiaries.
'Some of the work we have been doing suggests the swings in consumption in the upper quintile of American households is really quite a significant and important element within the aggregate total of personal consumption,'' Greenspan said.
Reed made a jack-knife turn back to monetary policy. When asked about deflation, or a decline in the price level, Greenspan was reassuring, saying the economy is 'not close to a deflationary cliff''.
If such a threat did present itself, Greenspan said, the Fed wouldn't be bound by an overnight rate close to zero. Instead, policy makers could purchase 'assets all along the maturity spectrum of the yield curve''.
These were the 'unconventional measures'' the Fed discussed at its 29-30 January meeting as a way around the 'zero-bound policy constraint''. A few journalists and conspiracy theorists took the reference to unconventional means as acknowledgment the Fed is thinking about (or already) buying stocks.
What about the need for short-term stimulus?
'Um, I am in the process of thinking about that,'' Greenspan said. (He'll soak on it in the bathtub.) Hoping for another turn-of-phrase coup, Greenspan reiterated the economy's current slowdown represented a 'soft patch', not part of a cumulative weakening in activity. (Soft patch is shorthand for we can't explain the slowdown any other way.)
Alas, a bon mot such as 'irrational exuberance'' comes along only once in a lifetime. The trouble is, the economy is still paying the price.
Bloomberg newsroom, New York
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