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After dispelling rumors that he would announce his retirement at Stanford, Alan Greenspan, chairman of the Federal Reserve Board, spoke on campus Friday, Sept. 5, of his limited ability to predict the future based on history and statistics. The economic statistics that he monitors in order to set interest rates are inadequate, he said, and growing more inadequate quickly.
Speaking at the Faculty Club to guests of the Center for Economic Policy Research at its 15th anniversary dinner, the 10-year chairman of the Federal Reserve delivered one of his characteristically careful speeches, without any attempt at humor, to economists and business leaders who helped launch the West Coast think tank in 1982. Hosted by the center's former directors and advisory board chairs, guests were given a commemorative medal pressed with the likeness of Adam Smith and the center's motto in Latin, which translates in English to: "We think and we do." Earlier in the day, about 150 of them attended panel discussions of the last 15 years of the U.S. economy.
Because Greenspan's speech was scheduled for a Friday evening when nearly all the world's markets are closed, some analysts and investors speculated that the chair of the world's most powerful central bank might give a hint of what he intends to do later this month when the board meets to consider changes in short-term interest rates. The Reuters news agency noted that the last time Greenspan delivered a high-profile speech when markets were closed, his remarks on "irrational exuberance" in the stock market triggered a worldwide rush to sell stocks, bonds and the dollar amid fears of an impending crash. This time, published rumors about his resignation, which began at the Chicago Board of Trade, according to his press secretary, may have caused the price of stocks to dip early in the day. Prices rebounded after Greenspan issued a statement calling the rumors "nonsense."
For Greenspan, who came to Stanford from a tennis vacation in Monterey, the academic venue was an opportunity to elaborate his growing doubts, recently voiced to Congress, about the reliability of U.S. economic statistics. His only hint that the Fed might try to head off inflation by raising interest rates in the near term came when he said that "with labor resources currently stretched tight, we need to remain on alert."
Most of his talk seemed aimed at detailing for scholars the types of new research that would make his job easier. That job, he said, is using the one tool he has the setting of short-term interest rates to maximize the country's potential for sustainable economic growth by stabilizing prices. He noted the role of two Stanford/Hoover Institution economists Milton Friedman and John Taylor in devising working parameters for doing just that.
Friedman, a Nobel laureate who introduced Greenspan, said the current chairman was the best Federal Reserve chair ever; however, he couldn't resist adding that he would prefer to "abolish the Federal Reserve and replace it with a computer." Greenspan returned the compliment without a humorous jab. He said Friedman has had "as much, if not more, impact on the way we think about monetary policy" as any person in the second half of this century.
In the late 1970s, Greenspan said, "the Federal Reserve's actions to deal with developing inflationary instabilities were shaped in part by the reality portrayed by Milton Friedman's analysis that ever-rising inflation rate peaks, as well as ever-rising inflation rate troughs, followed on the heels of similar patterns of average money growth. The Federal Reserve, in response to such evaluations, acted aggressively under newly installed Chairman Paul Volcker" to maintain more control over the money supply.
The goal of achieving price stability, because it encourages more sustainable growth, he said, has not changed in the past 15 years but the techniques the Fed uses have had to change because of "vast changes in technology and regulation" of markets and financial institutions.
A long-standing debate exists over whether central bank leaders in setting monetary policy should be free to use their own discretion or whether they should follow very specific rules that everyone can anticipate. Greenspan explained why he generally preferred a rule-based system, but he cautioned that "policy rules might not always be preferable."
He referred to a highly regarded rule, authored by Taylor, until last month the Stanford policy center's director, that uses readings on national outputs and prices as guideposts for setting interest rates. Like all rules, Greenspan said, Taylor's rule assumes that the future will be like the past. "Unfortunately, however, history is not an infallible guide to the future, and the levels of these two variables are currently under active debate."
He noted some of the events the Federal Reserve has confronted since 1982 that were "outside our previous experience." Those included the stock market crash of October 1987, the commercial property price bust of the late '80s and early '90s, and an unprecedented "credit crunch" in 1990 and 1991.
"Most recently, the economy has demonstrated a remarkable confluence of robust growth, high resource utilization and damped inflation," he said, with incoming data that does not conform to previous experience. "Specifically, the persistence of rising profit margins in the face of stable or falling inflation raises the question of what is happening to productivity," he said.
"The still open question is whether productivity growth is in the process of picking up," he said. "For it is the answer to this question that is material to the current debate between those who argue that the economy is entering a 'new era' of greatly enhanced sustainable growth and unusually high levels of resource utilization, and those who do not. "
The Fed is interested in stabilizing prices, he said, because "evidence has continued to accumulate around the world that price stability is a necessary condition" for sustainable growth. But policymakers and academicians face "difficult issues of concept and measurement" in charting prices, he said, at a time when the pace of change is accelerating.
It was easier to price a pound of electrolytic copper or a yard of cotton cloth in the past, he said, than a unit of software or a medical procedure today. "How does one evaluate the price change of a cataract operation over a 10-year period when the nature of the procedure and its impact on the patient has been altered so radically?"
The Fed tries to maintain stability in current final prices for goods and services, rather than in prices for future goods and services as they are reflected in such markets as those for stock and real estate, Greenspan said. Yet current final prices were stable in Japan in the mid to late 1980s when "soaring asset prices distorted resource allocation and ultimately undermined the performance of the [Japanese] macroeconomy." History, he said, is "somewhat ambiguous on the issue of whether central banks can safely ignore asset markets, except as they affect product prices."
Greenspan finished by urging the center to continue to do "focused and relevant academic research" to guide policymakers like himself.