Your flexible friend
Jul 21st 2004
Jul 21st 2004
From The Economist Global Agenda
The hard times are behind us, says Alan Greenspan. And the American economy is flexible enough to withstand any troubles on the horizon
WHEN Alan Greenspan, the long-serving chairman of the Federal Reserve, needs help nodding off at night, he sometimes reads his own speeches. This confession, made on Tuesday July 20th during his twice-yearly Humphrey-Hawkins testimony to the Senate, brought a ripple of laughter from the assembled lawmakers, and a murmur of recognition from Fed-watchers everywhere. In the past few months, Mr Greenspan has succeeded in making monetary policy soporific. He has said nothing that he hasn’t been keen to repeat several times. He has done nothing that he hasn’t been careful to talk about well in advance.
This week’s testimony, delivered first to a Senate committee and the next day to a committee from the House of Representatives, will make for prime bedside reading. With the recovery proceeding apace, a tighter monetary policy was both safe and necessary, he said. Rates will most likely rise at a “measured” pace, but if he has to raise them faster to contain inflation, he will.
Inflation had picked up, he conceded, partly due to a “transitory” surge in energy prices, partly due to sustained strength in the economy. Mr Greenspan’s favourite measure of inflation (the price index for core personal consumption expenditures) stood at 1.6% in May, compared with just 0.8% in December. He does not think these rises will continue, but neither does he discount the possibility that more “deep-seated” inflationary pressures are building, as yet unseen in the data.
So far, Mr Greenspan noted, inflation could not be blamed on higher labour costs. Rather, price rises were passing straight into the corporate bottom line. In the year to the first quarter, prices had risen by 1.1%, all of which can be attributed to a rise in profit margins. Fully 12% of the value of corporate output is now being taken as profit, up from just 7% in the autumn of 2001.
Buoyed by such strong flows of cash, corporate America is once again prepared to hire and invest. One or two companies with more money than they can easily spend, such as Microsoft (see article), are even handing some back to shareholders. But though companies are happy to invest again, they are still reluctant to borrow to do so. They remain careful to live within their means, their outlays on new equipment and replenished inventories never exceeding their cash flow. Mr Greenspan is surprised by the durability of this diffidence. “The protracted nature of this shortfall is unprecedented over the past three decades,” he pointed out. We are still, he thinks, living with the legacy of past corporate excesses and the fear of present terrorist dangers.
Mr Greenspan wants to return monetary policy to a more neutral stance. But no one knows quite where neutrality lies. The idea owes something to Knut Wicksell, a 19th century Swedish economist, who posited a “natural” rate of interest that would balance the supply and demand for capital. One senator, perhaps not au fait with his dead Swedish economists, asked for a number. But Mr Greenspan remained coy. We know when we are above the neutral rate, he observed, and we know that now we are below it. But we won’t know we have arrived at the neutral rate until we get there.
What is beyond doubt is that interest rates have been unnaturally low for an unusual length of time. Some fear that Mr Greenspan’s “accommodative” monetary policy has given households too much room to acquire debt. Now that rates are rising, households that have overstretched themselves may begin to feel the strain. Mr Greenspan disagrees. Far from tempting Americans to spend recklessly, low interest rates have helped them improve their balance sheets, he says. Even as they acquire new debt, they have shifted old debt to longer, cheaper rates. In the space of a year, between mid-2002 and mid-2003, homeowners refinanced almost half of their outstanding mortgage debt at more favourable rates, he points out.
If monetary tightening proceeds at the “measured pace” Mr Greenspan deems likely, he expects businesses and households to cope admirably. Financial strain will be confined to “individual instances”. Capital losses, particularly on bonds, will fall primarily on financial institutions that are well capitalised and well prepared.
Mr Greenspan’s speeches may be soporific, but the dreams they induce are cosy and sweet. His testimony revealed once again his confidence in the famed “flexibility” of America’s economy. Mr Greenspan’s is a world of smooth adjustments: households will make just such an adjustment to higher interest rates, he says; the dollar will adjust gradually to the slowing or withdrawal of foreign capital flows. As China slows, America will—you guessed it—adjust smoothly. America the Flexible bends before the prevailing winds, it does not break.
WHEN Alan Greenspan, the long-serving chairman of the Federal Reserve, needs help nodding off at night, he sometimes reads his own speeches. This confession, made on Tuesday July 20th during his twice-yearly Humphrey-Hawkins testimony to the Senate, brought a ripple of laughter from the assembled lawmakers, and a murmur of recognition from Fed-watchers everywhere. In the past few months, Mr Greenspan has succeeded in making monetary policy soporific. He has said nothing that he hasn’t been keen to repeat several times. He has done nothing that he hasn’t been careful to talk about well in advance.
This week’s testimony, delivered first to a Senate committee and the next day to a committee from the House of Representatives, will make for prime bedside reading. With the recovery proceeding apace, a tighter monetary policy was both safe and necessary, he said. Rates will most likely rise at a “measured” pace, but if he has to raise them faster to contain inflation, he will.
Inflation had picked up, he conceded, partly due to a “transitory” surge in energy prices, partly due to sustained strength in the economy. Mr Greenspan’s favourite measure of inflation (the price index for core personal consumption expenditures) stood at 1.6% in May, compared with just 0.8% in December. He does not think these rises will continue, but neither does he discount the possibility that more “deep-seated” inflationary pressures are building, as yet unseen in the data.
So far, Mr Greenspan noted, inflation could not be blamed on higher labour costs. Rather, price rises were passing straight into the corporate bottom line. In the year to the first quarter, prices had risen by 1.1%, all of which can be attributed to a rise in profit margins. Fully 12% of the value of corporate output is now being taken as profit, up from just 7% in the autumn of 2001.
Buoyed by such strong flows of cash, corporate America is once again prepared to hire and invest. One or two companies with more money than they can easily spend, such as Microsoft (see article), are even handing some back to shareholders. But though companies are happy to invest again, they are still reluctant to borrow to do so. They remain careful to live within their means, their outlays on new equipment and replenished inventories never exceeding their cash flow. Mr Greenspan is surprised by the durability of this diffidence. “The protracted nature of this shortfall is unprecedented over the past three decades,” he pointed out. We are still, he thinks, living with the legacy of past corporate excesses and the fear of present terrorist dangers.
Mr Greenspan wants to return monetary policy to a more neutral stance. But no one knows quite where neutrality lies. The idea owes something to Knut Wicksell, a 19th century Swedish economist, who posited a “natural” rate of interest that would balance the supply and demand for capital. One senator, perhaps not au fait with his dead Swedish economists, asked for a number. But Mr Greenspan remained coy. We know when we are above the neutral rate, he observed, and we know that now we are below it. But we won’t know we have arrived at the neutral rate until we get there.
What is beyond doubt is that interest rates have been unnaturally low for an unusual length of time. Some fear that Mr Greenspan’s “accommodative” monetary policy has given households too much room to acquire debt. Now that rates are rising, households that have overstretched themselves may begin to feel the strain. Mr Greenspan disagrees. Far from tempting Americans to spend recklessly, low interest rates have helped them improve their balance sheets, he says. Even as they acquire new debt, they have shifted old debt to longer, cheaper rates. In the space of a year, between mid-2002 and mid-2003, homeowners refinanced almost half of their outstanding mortgage debt at more favourable rates, he points out.
If monetary tightening proceeds at the “measured pace” Mr Greenspan deems likely, he expects businesses and households to cope admirably. Financial strain will be confined to “individual instances”. Capital losses, particularly on bonds, will fall primarily on financial institutions that are well capitalised and well prepared.
Mr Greenspan’s speeches may be soporific, but the dreams they induce are cosy and sweet. His testimony revealed once again his confidence in the famed “flexibility” of America’s economy. Mr Greenspan’s is a world of smooth adjustments: households will make just such an adjustment to higher interest rates, he says; the dollar will adjust gradually to the slowing or withdrawal of foreign capital flows. As China slows, America will—you guessed it—adjust smoothly. America the Flexible bends before the prevailing winds, it does not break.
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