Mindful of ‘73, Fed Chief Won’t Waver on Rates : Economy: Amid an oil shock and pressure to keep the expansion going, Alan Greenspan is unmoved. And that means interest rates likely won’t go anywhere either.

Remember October, 1973? Alan Greenspan does, and as current chairman of the Federal Reserve, he’s determined not to let history repeat itself.

Seventeen years ago, in a situation eerily like today’s, war was breaking out in the Middle East. An Arab oil embargo triggered unprecedented worldwide fuel shortages and a huge jump in energy prices. The Federal Reserve, worried that the oil shock might bring on a recession, cut interest rates and eased credit. But the move only unleashed pent-up inflation, and five months later the central bank was forced to slam on the brakes to keep prices from spiraling out of control. The result: The nation suffered its worst recession since the 1930s.

Greenspan stepped into the middle of that disaster, taking the job of economic adviser to then-President Gerald R. Ford at the worst moment of the 1974-75 downturn. Despite the subsequent upturn, he still blames the memory of that economic collapse for Ford’s narrow 1976 election defeat to Jimmy Carter. Nor was it the last such lesson. In 1979, the Middle East exploded again, with similar economic consequences--and Carter lost his presidency.

Today, the Persian Gulf crisis growing out of Iraq’s invasion of Kuwait is threatening to do it again. And even though the U.S. economy was teetering on the brink of recession before the invasion, placing the Fed under the gun to stimulate new growth, Greenspan is saying no.

“The oil shock has clearly increased the probability of both inflation and recession,” the Fed chairman told lawmakers earlier this month. Unfortunately, he added, “there is no policy initiative that can in the end prevent the . . . cut in our standard of living that stems from higher prices for imported oil.”

Even though the U.S. economy has practically stopped growing--and may be about to get even sicker, many central bankers and independent analysts argue--the Fed is nearly powerless to use the traditional prescription of lower interest rates. If Greenspan were to ease credit, the move would just spread the fever of inflation throughout the economy, requiring the central bank to reverse direction and bring on an even worse downturn next year.

“Greenspan doesn’t want to oversee a rerun of the two previous oil shocks,” said Jerry Jordan, chief economist at First Interstate Bank in Los Angeles and a former Reagan Administration economic adviser. “That means he can’t open the monetary spigots right now. His hands are bound and tied.”

Greenspan has some powerful backing for his hold-the-line approach, even if it risks bringing to an end the nearly 8-year-old U.S. economic expansion. Top economic officials from around the world who gathered here this past week for the annual meeting of the International Monetary Fund and the World Bank almost universally endorsed a policy of high interest rates to fight inflation.

“The lessons we learned in 1973 and ’74 ought not be forgotten,” said British Chancellor of the Exchequer John Major. “You simply do not accommodate inflationary pressures.”

Moreover, the IMF itself believes that the global economy can weather the storm without a serious downturn, provided economic policy-makers stay the course and don’t try to offset the impact of higher oil prices with lower interest rates or more government spending.

“We hope that lessons of the past will have been learned, and some of the mistakes will be avoided,” said Jacob Frenkel, the IMF’s top economist.

But the Bush Administration, although giving lip service to today’s hard-won economic consensus, is clearly worried that the Fed is about to make the same mistake often attributed to generals who go down to defeat fighting the last war.

“Most people are blaming Saddam Hussein, but we’re going to call this the Greenspan recession because it’s clearly his fault,” said Richard Rahn, chief economist at the U.S. Chamber of Commerce. “The Fed has kept interest rates much higher than they need to be and has failed to articulate a coherent and consistent policy to bring down inflation and promote economic growth.”

White House officials are committed to keeping the expansion going at all costs. They are more worried than the Fed about the possibility that an economic slump could hit real estate so hard that today’s S&L; woes, bad as they are, would turn into a full-fledged financial nightmare through a major banking collapse. Already, Chase Manhattan--the nation’s second-largest bank--has announced $1 billion in fresh writeoffs to cover real estate losses and has said it will lay off 5,000 employees. And banking officials say another New York bank is in even worse shape.

Administration officials also fear that even a mild recession could push the federal deficit from roughly $200 billion this year to a mind-boggling $400 billion in fiscal 1991.

Despite the inflationary blow from higher oil prices, Treasury Secretary Nicholas F. Brady considers it only a temporary problem. He still wants the Fed to pump out more money in hopes of propping up the flagging economy. Although Brady has quieted down since the Iraqi invasion and not everyone in the Administration agrees with his approach, the White House is nonetheless counting on Greenspan to cut rates sharply once the Administration and Congress reach agreement on a deficit package.

But even that hope may be in vain.

The Gulf crisis hit as the U.S. economy was already facing serious problems and only added to Greenspan’s dilemma. The underlying rate of inflation moved above 5% even before August’s oil price shock, while the dollar has fallen because of higher interest rates abroad. The Fed cannot afford to let the greenback’s decline get out of control.

“There are no easy choices for U.S. policy-makers,” said Lawrence Chimerine, an economist at the Economic Strategy Institute, a new Washington think tank that advocates a harder trade policy and government help to restructure the economy. “If we bring interest rates down, it makes it even more difficult to attract the foreign capital we need,” Chimerine said. “But if we don’t lower rates, it further weakens the domestic economy.”

Despite the risks to the domestic economy, Greenspan’s predecessor at the Fed, Paul A. Volcker, is urging the central bankers not to succumb to private pleas from the Administration for an easier monetary policy. “After all that has happened in recent years,” Volcker told an IMF forum, “to embark on an approach of tolerating, or even aiding and abetting, the inflation process would soon be counterproductive.”

Moreover, not everyone is convinced that the economy is headed for the rocks.

“I still don’t see the underlying conditions for a recession,” said David Levine, chief economist at the New York investment house Sanford C. Bernstein & Co. “Sure, if oil prices go a lot higher, we could fall over the edge, but no recession in recent history has begun without much greater Fed tightening or a much greater price shock than we’ve had so far.”

But if, as many business leaders now fear, a recession is almost inevitable anyway, some are urging the Fed not to stand in the way.

“We’ve had an eight-year expansion without a meaningful adjustment. That can’t continue,” Marion Sandler, president and chief executive of Oakland’s Golden West Financial Corp., recently told Fortune magazine. “Let’s shake it out and get it over with.”

At a Fed meeting in late August, officials say, a majority of the members of the central bank’s policy-making Federal Open Market Committee granted Greenspan the leeway to ease short-term rates slightly. But the chairman has been reluctant to exercise his authority for fear that Wall Street would read such a move as a craven surrender to rising inflation--and would react by driving up rates on long-term government bonds, wiping out any brief gain by making home mortgages and other loans more costly.

“Policy actions . . . could easily be counterproductive,” Greenspan warned.

The Open Market Committee is scheduled to meet again Tuesday. With the inflation threat looking worse and the economy apparently still inching ahead, it looks as though Greenspan will have strong support for digging in his heels.

Last week, even as the odds of recession loomed higher with a Commerce Department report that the U.S. economy eked out a bare 0.4% gain in the April-June quarter, Fed Governor Wayne Angell warned not to expect central bankers to retreat from their determination to resist inflation.

“Monetary policy ease designed to offset or mitigate the real effects of this oil price increase risks turning a relative price increase into a general price increase,” Angell said in a speech in Florida. Such an outcome would be “intolerable,” he added.