Fareed Zakaria :
© Newsweek, February 16, 2001
The Wide World's Banker of Last Resort Looks Overextended
NEW YORK Alan Greenspan is surely the least criticized
American public official since George Washington.
However, looking at the U.S. economy today, one has to
wonder if the Federal Reserve's handling of it in the past
three years has been as wise or as consistent as the
Greenspan myth makes out. Rather than keep a steely
gaze on the core rate of inflation, the Federal Reserve's
historical role, Mr. Greenspan has massaged interest
rates in response to the crisis of the moment, whether it
be Russia's default, failures of hedge funds or bubbling
technology stocks. These are all serious concerns, but
should the Fed be using its nuclear weapon - short-term
interest rates - to coax and cajole global bankers and
American investors to behave well?
Consider what was supposed to have been Mr.
Greenspan's finest hour. In the late fall of 1998, after
Russia's default and a panic in global markets, Mr.
Greenspan suddenly and dramatically cut interest rates.
The markets rallied and, so the mythology goes, the global
economy was saved.
But it was exactly the wrong time to cut rates in America.
The U.S. economy was roaring - growing at close to 6
percent in the last quarter of 1998. The Fed boosted the
economy when it was already on steroids.
Mr. Greenspan's dilemma in 1998 was that the Federal
Reserve Board had become the banker of last resort of
the global economy. This was a contradiction of its role as
watchman of American inflation and growth. In solving a
global problem, Mr. Greenspan may have caused a local
one.
The rate cuts weren't all. He had bought into the
over-hyped fears about Y2K, and in late 1999 the Federal
Reserve swamped the markets with as much liquidity as
the private sector wanted. The result of low rates and easy
money at a time of galloping growth produced Mr.
Greenspan's nightmare, an out-of-control stock market.
Spooked by the spiraling stock market, Mr. Greenspan
started raising rates in June 1999, only six months after he
had cut them, and raised them six times to 6.75 in an
economy in which inflation was virtually nonexistent except
for energy costs, which Mr. Greenspan had long
maintained should not be crucial in the Federal Reserve's
considerations. The high interest rates proved to be an
overdose. In his testimony on Jan. 25, Mr. Greenspan
announced that growth had slowed to close to zero.
Because the Fed could not have wanted zero growth, by
his own admission he had gone too far.
Now he has begun slashing rates in the hope that the
stock market will rally and business and consumer
confidence will rise. After these three years of seesawing
rates, the image that emerges of Mr. Greenspan is quite
different from the popular perception. He has veered from
guardrail to guardrail, reacting to one crisis only to
produce another.
It is impossible to fault Mr. Greenspan for his choices at
the time - he made brave and intelligent decisions in a
brutal environment. The atmosphere in 1998 was spooky;
the stock market was frothing in 1999. Hindsight is 20-20.
But that is why we can learn something from it.
Market volatility is here to stay. And the tension between
the Fed's international role and its domestic one will
increase as countries around the world, particularly in
Latin America, link their currencies to the dollar.
What we will rediscover in the next few months is that
economics is a human science, full of uncertainty, intuition
and psychology. From the purchasing manager of a store
who must decide whether an economy is in a soft slump or
a hard landing to the Fed chairman, people act on the
basis of imperfect information. And they are all subject to
human error, even Alan Greenspan.