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October 27, 1997

Fed Chief's Policy Mostly Guessing Game!

By Howard Hobbs PhD, CSU Fresno ISI Campus Sponsor

FRESNO - When the Federal Reserve Board met last August, the unemployment rate had dropped to low levels. In the past, this would have been read as a signal that for inflationary wage increases.

Federal Reserve economists were predicting inflation would be higher in 1996 than in recent years. Presidents of several Fed regional banks, mindful that the Fed often fights inflation too slowly, wanted higher rates. Even Fed Governor Janet Yellen, hardly an anti-inflation zealot, was uneasy.

Federal Reserve chairman Alan Greenspan wanted to leave rates alone. And with just one exception, Fed policy makers agreed. Greenspan dominates the Fed. He would have had the necessary votes to raise rates, if he wanted.

In retrospect, the late-summer decision looks prudent. There has been a rebound in economic growth. However, wages and prices remain placid. How did Greenspan, the 70-year-old economic forecaster now in his 10th year as Fed chief, do it?

In just released transcripts of Fed's deliberations, Greenspan's secret for divining the economy's direction is this. He relies on a sophisticated seat-of-the-pants economics theory to direct the Clinton administration's monetary policy. He arrived at this solution after nearly 50 years of guessing games when pondering the state of the economy.

Greens The Journal story reported that Greenspan says he reads Fed staff reports while soaking in a bathtub. He once told a U.S. senator the best thing about being the nation's most powerful economic policy maker is that it gives him access to "the data" which, it has now been disclosed, that he disregards.

In spite of his unorthodox reading habits and his guessing games on interest rates, he has reportedly complained to the Big Three auto makers in 1994 that their decision to stop reporting auto sales every 10 days "significantly diminished our ability to monitor business activity."

Recently, he halted a closed-door briefing to grill staff economists on the peculiarities of economic indicators of the Mortgage Bankers Association's mortgage-refinancing index in weeks that have a legal holiday.

Even longtime friends are often mystified by Greenspan's approach to economics. "He looks at hundreds of variables. Out of them he somehow divines something about the economy. No one knows how he does it," says Allan Meltzer, a Carnegie-Mellon University economist.

Greenspan does not trust computerized econometric models. He only trust his own biases. He doesn't seem to comprehend sophisticated economics models developed by the writer like those of the Systematic Supply & Demand Analyses through the research database at the Economics Institute models in Washington, D.C., or the inter-regional models developed by George Treyz of MIT which link low unemployment and future inflation.

Greenspan doesn't watch economic trends, such as how fast suppliers fill orders from factories, that usually signal a buildup of inflationary pressures.

In making the monetary policy forecasts for the Clinton White House he searches for the some factor that he judges as distinguishing the current business cycle from previous ones. If he can find it, he then makes a forecast based upon what he divines from its meaning.

It's a foolish approach.

For example Fed transcripts show that by using the bathtub reading and the >seat of the pants economics theory Greenspan was late to realize that the economy was sliding into recession in 1990 and that his usually reliable measures of the industrial economy were blinding him to the reluctance of bankers to lend and of consumers and companies to borrow.

In his record at the Fed, he has been faulted for cutting rates too slowly during the painfully sluggish recovery of 1991. But he eventually recognized the severity of the credit crunch, described it as "a 50-mph headwind" slowing the economy and used that notion to justify lowering rates and keeping them low.

Greenspan is now trying to divine the meaning of why workers' fear losing their jobs restrains them from seeking the pay raises that usually crop up when employers have trouble finding people to hire.Greenspan hopes to find the meaning of this, soon.

Even if the economy didn't slow down as he expected, he told Fed colleagues last summer, he saw little danger of a sudden upturn in wages and prices. "Because workers are more worried about their own job security and their marketability if forced to change jobs, they are apparently accepting smaller increases in their compensation at any given level of labor-market tightness," Greenspan told Congress at the time.

At meetings of the Fed's rate-setting Federal Open Market Committee, Greenspan uses similar obtuse language, avoiding economics concepts that have an established reference in public policy economics research.

To cope with the vagueness and imprecision of Greenspan's communications, Fed Governor Yellen, herself an academic economist, translates Greenspan's worker-insecurity divining into more respectable language. She wrote him a memo turning his notion into elegant reasoning, and he distributed it to other Fed policy makers.

However, Greenspan has disdained that translation and has now found what he deems as some way to measure worker insecurity. He is maintaining that when jobs are plentiful, more people are usually willing to quit one job and seek another. This, he reasons, might raise the number of newly unemployed who tell government survey-takers they left their last job voluntarily. Greenspan testified before Congress recently, that he is seeing the first signs of the long-expected wage increases, an indication that the unusual wage restraint may be ending.

Greenspan has not revealed whether he truly bases monetary policy on such arguments, or whether they are an elaborate cover for what amounts to just making a lucky guess. His idiosyncratic approach gives him enormous flexibility, much more than if he tied monetary policy to the ups and downs of the money supply, the price of gold or strict targets for inflation or economic growth.

Ironically, Greenspan did study economics at Columbia University under Arthur Burns, who was later a Fed chairman. Greenspan's private-sector forecasts were not consistently better than those of any other forecasters.

What Greenspan did, however, was to make a lot of money explaining to companies how he thought the economy worked. In the years between his 1974-to-1977 stint as President Ford's chief economist and his 1987 Fed appointment, news reports said he got as much as $22,000 for a single speech about the future of the economy.

Greenspan keeps two computer terminals on his desk. With one he checks on financial markets. With the other he taps into the Fed's statistic database. The Fed's domestic economic-research unit tracks 18,500 data series, 3 1/2 times as many as it did before he arrived.

Another clever trick Greenspan has learned is not to put his forecast in writing.


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