Why Greenspan Turned on a Dime

Now that the U.S. economy has been officially pronounced as sick, Alan Greenspan, the Federal Reserve Board chairman, has signaled what appears to be a policy shift to pump up credit. Belated or not, that focus on increasing the money supply is the right move to help revive a sagging economy and improve consumer confidence.

In testimony before the Senate Banking Committee on Wednesday, Greenspan said the Fed was considering additional interest rate cuts to combat the recession. He also indicated the Fed may use other strategies, still to be unveiled, to offset the continuing credit crunch that could prolong the slowdown.

There has been much debate about this recession’s trigger. The Fed suggests it was the Persian Gulf crisis and high oil prices. Others say the economy was slowing even before the August invasion of Kuwait and that the Fed moved too slowly to free the economy from high interest rates. The Fed has cut rates six times since August, but banks, fearful that new loans would be branded by regulators as bad, have been reluctant to lend.

As a result, the growth in the nation’s money supply--one measure of performance--has remained annoyingly flat. This now troubles the Fed, even though until recently it had put top priority on containing inflation through interest rates.

In recent testimony before theHouse Budget Committee, Greenspan said, “I would think that the money supply in this particular environment will give us reasonable signals relevant to how the economy is emerging. This is something I would not have said two years ago, but I think we’re beginning to see the money supply as being useful as a reflective force.”

The economy, despite the recession, retains some underlying muscle--no bloated inventories, booming exports, moderating inflation and a housing bust that may just have bottomed out. War needs are expected to be met by existing supplies. All this bodes well for interest rate cuts that would not necessarily trigger new inflation.

Although the costs of war are likely to plunge the government even more deeply in the red, Greenspan is urging Congress not to tamper with last fall’s deficit-reduction package and not to levy a war tax. This is vintage Greenspan with his characteristic caution.

“The uncertainties in the current situation are great and the risks of making policy mistakes are high,” he told the House committee. “An overly aggressive monetary easing could end up being counterproductive.”

But you can bank on the proposition that without careful easing of monetary policy, the economy may have a hard time, short of a miracle, getting back on its feet.