Fed’s Greenspan Is Likely to Play Key Policy Role

After more than a year as head of the Federal Reserve, at least one thing is clear about Alan Greenspan: He’s no Paul A. Volcker.

And that is by no means all bad. Although Volcker became something of an economic folk hero for his role in rescuing the nation from double-digit inflation nearly a decade ago, he was never entirely trusted by either President he served. For his part, Volcker assiduously reigned above the political fray during his eight years at the central bank but was never able to persuade Congress and the White House to narrow the federal budget deficit enough so that painfully high interest rates could be lower.

But Greenspan, who once served as President Gerald R. Ford’s chief economic adviser, is more comfortable in the role of presidential confidant. That could make him the right man in the right place for President-elect George Bush at a time when the White House faces a number of immediate economic challenges.

“My feeling is (that) the real economic strongman (in the Bush Administration) is going to be Greenspan,” says Larry Kudlow, a former Reagan Administration economic official who is now a Wall Street economist. Secretary of State-designate James A. Baker III, who as Treasury secretary was the economic heavyweight under President Reagan, “simply isn’t going to have the time,” Kudlow said.

A few Bush advisers, particularly his more conservative aides, doubt that Greenspan’s clout will be as strong as it potentially could be. “Some of us think he has been a very passive Fed chairman,” says one Bush economic adviser, who spoke on condition that he not be identified.

There are others who worry that Greenspan, if he becomes too intimately involved in Bush Administration economic policy, could rob the Fed of some of its vaunted freedom to set monetary policy safely insulated from politics.

But so far, Greenspan has conspicuously and successfully demonstrated his independence of White House pressures, and, by doing so, has improved his stature dramatically on Capitol Hill.

Most analysts believe that Greenspan now will have every opportunity to be a key player in influencing how the government attacks the severe federal budget deficit and the huge financial problems of the savings and loan industry.

Pillar of GOP Elite

Greenspan’s pedigree certainly is right for the role. For years a respected New York economist, Greenspan has long been a pillar of the mainline Republican elite, from which Bush is drawing the core of his senior policy team. Many of Bush’s top officials, such as Baker, budget chief Richard G. Darman and National Security Adviser Brent Scowcroft, first tasted power in Washington during the Ford or Richard M. Nixon administrations, as Greenspan did.

“No bomb throwers here,” says political analyst William Schneider. “The Republican Establishment is back.”

During his first 16 months as Fed chairman, Greenspan has displayed a number of significant differences from Volcker. Most important, he is running the often-secretive Fed with a far looser hand than his aloof and imperial predecessor did. “Greenspan plays the clarinet and he knows what it is to lead an orchestra,” says David Hale, chief economist at Kemper Financial Services in Chicago. “Volcker was more of a soloist.”

Candor ‘Surely Healthier’

The new openness and diversity has raised some eyebrows among longtime Fed watchers accustomed to their own Delphic role in interpreting the vague smoke signals that usually have emanated from past Fed chairmen. But the surprising candor from Greenspan and a number of his colleagues, wrote a group of anonymous senior officials in a private Fed document circulated recently, “is surely healthier than secrecy which has so often characterized Fed behavior in the past.”

Inside the Fed, Greenspan has demonstrated his political acumen by working intimately with Vice Chairman Manuel Johnson, a respected former Reagan Administration official who is a leader among the other six Washington-based Fed governors Reagan appointed. At the same time, he also has forged a strong coalition with the 12 regional Fed bank presidents, who rotate voting power on the Fed’s key monetary policy board.

“There’s been a resurgence of the Fed bank presidents, in part because guys like (Gerald) Corrigan (of the New York Fed), Gary Stern in Minneapolis, Lee Hoskins, (president of Cleveland Bank) and San Francisco’s (Robert T.) Parry have so much experience to go on,” says Lyle Gramley, a former Fed governor who is now chief economist at the Mortgage Bankers Assn. “And Alan Greenspan knows where his support is. He’s built his base among the bank presidents, and when he needs them, they’re there.”

Signs of Potential Rift

Earlier this year, just before the Fed’s August announcement of a discount rate increase to 6.5% for the central bank’s lending rate to financial institutions, there were signs of a potential rift between the Fed board governors and regional heads over monetary policy. Many of the presidents, concerned that economic growth above about 2.5% would spark long-smoldering inflationary embers, found themselves heading on a collision course with some of the Reagan appointees who are willing to tolerate more rapid growth as long as it does not set off other inflation alarm bells.

The looming dispute at the August policy meeting was avoided when Greenspan managed to corral the Fed board into unanimously voting for a 0.5 percentage point hike just days before the Republican political convention. But some of the scars have not fully healed, officials acknowledge indirectly.

The Fed’s policy-making open market committee “is a large group and it requires a strong exercise in diplomacy and personal skills to forge a consensus,” Johnson says. “One of my responsibilities, as I see it, is to help maintain liaison among the (committee members) so we don’t have any pulling apart between the governors and the presidents.”

Greenspan’s Fed wins high praise for its skillful management of the financial panic surrounding the October, 1987, stock market crash. But a more difficult test of Greenspan’s leadership still lies ahead.

Next year, he must try to prod Bush and Congress to make a deal to narrow the budget gap to relieve that economic burden, while containing the inflationary pressures percolating in the expanding U.S. economy. Even if they buckle down on the budget, analysts say, Greenspan must avoid a commitment to seeking lower interest rates because he may not be able to deliver right away.

In fact, on the eve of this week’s meeting of the open market committee, several top Fed officials are warning that higher interest rates may be needed to restrain further the pace of economic expansion. “The economy still is growing at a pace that cannot be sustained in the long run without higher inflation,” Parry said last week.

Little Room to Maneuver

With much of the economic slack of the early 1980s now gone and unemployment falling to its lowest levels in 14 years, the Fed has very little room to maneuver. If it tightens policy by pushing interest rates just a little too high, it risks pushing the economy over the brink into recession. But if it fails to restrain the money supply enough, it faces the danger of allowing the inflationary dragon to emerge from its long slumber. To many economists, that means that the Fed now faces the toughest test in years--in some ways an even more difficult task than engineering the prolonged deep recession Volcker accepted as the price for wringing double-digit inflation out of the economy.

“We’ve had six years of running room, but now there’s no room for error,” Kemper’s Hale says. “Greenspan first will have to fight a guerrilla war, then trench warfare and finally full-scale, hand-to-hand combat. Volcker just dropped the atomic bomb.”

With underlying inflation inching up toward 5%, the Fed is moving toward trench warfare, relying on the only real weapon in its arsenal--higher interest rates. The long-term goal is to squeeze inflation lower, but for now the Fed seems satisfied if it can simply avoid the wide fluctuations in inflation and interest rates that characterized the economy of the 1970s and early 1980s.

‘Longer-Run Problem’

“The Fed is operating within a much narrower band, and that’s a very positive development,” says Jerry Jordan, a former White House economic adviser to Reagan who is now chief economist at First Interstate Bank in Los Angeles. “They seem to be avoiding the booms and busts, feasts and famines. But there always seems to be a short-run reason for not dealing with the longer-run problem that even 4% to 5% inflation is still too high.”

Although the Fed likes to maintain an atmosphere of omniscience, the reality is that shaping monetary policy can be just as confusing as any battlefield. “We play it by ear,” Johnson says, “making adjustments as we go along when the facts don’t fit.”

In trying to keep the economy on an even keel, Greenspan faces a difficult balancing act of his own. He would like Bush to succeed in tightening fiscal policy by cutting spending, but he has to keep enough distance from the new Administration to maintain the Fed’s credibility as a bulwark against higher inflation.

“Greenspan has to remain independent to ensure his place in history,” GOP political analyst Kevin Phillips says. “He doesn’t want to be judged as a Republican political adviser. He wants to be judged as a central banker.”

Boosted Discount Rate

To demonstrate his distance from the White House to inflation-wary bond traders, Greenspan boosted the discount rate only weeks after taking office last year, despite initial private objections from Baker and other Reagan Administration officials.

Then, early this year, he publicly rebuked Michael Darby, a Treasury economist, who was worried along with other Administration monetarists that the money supply was growing so slowly that the economy would fall into a recession before the election. Although Fed and Administration officials talk and write to each other all the time, Greenspan made sure that a congressional committee heard his complaint about a Darby letter that was sent to Fed policy-making committee members just before a policy meeting.

Greenspan’s most striking declaration of independence came this summer when he surprised the Administration with the Fed’s boost in the discount rate just before the GOP convention. Then-Treasury Secretary Baker, who had just stated his intention to become Bush’s campaign chief, told reporters only a couple of days earlier that he did not expect any action by the Fed to raise rates.

President Usually Prevails

Nonetheless, for all his independence, no Fed chairman operates in a political vacuum. “For all the bad blood between Volcker and Treasury in Reagan’s first term, Paul basically did what the White House wanted,” Jordan says. “In the end, the President usually gets the monetary policy he asks for.”

Most analysts believe that Greenspan’s job would be a lot easier and interest rates would not have to be so high if a tighter fiscal policy helped carry some of the burden of preventing the economy from overheating. So now that he has established good relationships on both ends of Pennsylvania Avenue, Greenspan appears to be exceptionally well-placed to prod the new Administration and Congress toward a budget compromise that would narrow the deficit.

“He won’t get involved in the details, but Greenspan commands a lot of respect on Capitol Hill and from both (Treasury Secretary Nicholas F.) Brady and Bush,” economist Kudlow says. “Greenspan’s view is going to carry a lot of weight.”