When I was in Vietnam, people nearing the end of their tours of duty often focused on it to the point of obsession. Soldiers kept short-timers’ sheets — calendars showing the days left until their return home — and ritually checked off each day.
We all joked about how “short” we were in terms of days remaining. Approaching the end of their terms affected some people’s performance, but not others. That difference could be crucial.
Today marks the 18th anniversary of Alan Greenspan’s tenure as chairman of the Federal Reserve Board of Governors. But the end of his tour of duty is rapidly approaching. With Tuesday’s meeting of the Federal Open Market Committee behind him, Greenspan can preside over only three more such meetings before his replacement takes the helm. The question is whether being a “short-timer” is affecting his performance.
I cannot tell if it is, but the policy of gradualism — manifest again in yet another 0.25 point increase in interest rate targets Tuesday — increases the likelihood that a new chair will face difficult choices in 2006.
The current chair’s term statutorily ends in January 2006. No Fed governor can serve more than one full 14-year term. President Ronald Reagan appointed Greenspan to fill someone else’s unexpired term in August 1987. Then, President George H.W. Bush appointed him to a full 14-year term back in 1992. That ends Jan. 31, 2006, the first day of a two-day FOMC meeting that kicks off the 2006 monetary policy season.
So Greenspan will really only preside over three more meetings, on Sept. 20, Nov. 1 and Dec. 13 of this year. If the FOMC continues its gradualist, “accommodative” approach, three more raises will bring targeted Fed funds rate to 4.25 percent.
If news reports on this week’s FOMC meeting are any guide, the media will emphasize that these increases are yet more in a long series. Tuesday’s “Fed increases rates for a 10th time,” was typical. None said, “Despite another small rise, interest rates still well below normal levels,” even though that headline would be just as true as the first and a lot more relevant to the choices society faces.
By any measure, Fed control of the money supply has been very — as they put it — “accommodative.” That means that the money supply is growing fast enough to pose no constraint on the growth of output or employment. The trade-off of an accommodative stance is, of course, that faster money growth carries greater possibility of inflation.
The FOMC argues that inflation remains in check according to conventional measures like the Consumer Price Index and GDP Deflator. These indicators do show that increases in the prices they measure have been limited.
However, many famous economists who have studied relationships between money growth and price levels — from Irving Fischer a century ago to Milton Friedman in the mid-20th century — argued that a central bank needs to consider more than the prices of goods and services.
Excessive money growth, like the air in a balloon squeezed at one place, can pop out unexpectedly in unexpected places. It can cause unsustainable increases in the prices of assets like homes, farmland and corporate stocks. It can lead to high consumption levels financed by consumer indebtedness that households will find difficult to service over the longer run.
All that is happening now. Burgeoning manufacturing sectors in China and other Asian countries are driving down the prices of many goods globally. This goods-price deflation is masking inflationary pressures of excessive money growth that would otherwise show up in the CPI.
How does this affect Greenspan’s successor? Simply put, Fed complacency now increases the probability that the new guy or gal at the head of the big table will face tougher choices a year from now. Interest rates may require faster increases to make up for lost time now. Or continued high rates may be necessary even if housing prices begin to slide. The Fed may feel pressure to keep rates up to attract foreign buyers for U.S. Treasuries and mortgage-backed securities as foreigners become warier about ongoing U.S. budget deficits.
New central bank heads always face pressure to prove themselves to financial markets. Greenspan faced the October 1987 stock market crash less than 10 weeks after being sworn in. The usual temptation is to act decisively, that is, to pump up the money supply if the economy is slowing, or to crimp down hard if inflation is raising its ugly head, to establish a reputation for being in control.
Greenspan could do his successor a favor by getting some distasteful work out of the way in the three meetings left to him. One or more 50 basis point increases would get the FOMC out of the “we-can-only-move-25-points-at-a-time” rut in which it has entrapped itself.
As many military veterans can attest, just because your tour of duty is ending does not mean that you will be spared unpleasant but necessary tasks.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.