Fed Chairman Talks of Limits to His Powers

Federal Reserve Board Chairman Alan Greenspan warned Friday that huge swings in the stock market and big changes in home prices are making consumers more unpredictable in their behavior, making it much harder for policymakers to influence the economy.

“There can be little doubt that sizable swings in the market values of business and household assets have created important challenges for policymakers,” the Fed chairman said in a speech at the agency’s annual gathering at Jackson Hole, Wyo. The audience was a select gathering of economists, bankers, business officials and high-ranking Fed officials.

The easy cash obtained from home equity lines of credit and from stock market profits can be poured into sudden bursts of consumer spending, triggering quick changes in the performance of business. The Federal Reserve’s powers operate much more slowly, with a change in interest rates--either up or down--taking from six months to a year or more to ripple through the economy.

Greenspan, who is widely admired on Wall Street and in the business world as a key contributor to a decade of strong economic growth, offered a rare public admission of the limitations of his powers. And he acknowledged the great depths of uncertainty and guesswork in making policy decisions.

Traditional accounting systems may be inadequate tools for a computer-dominated high-technology age, the Fed chairman acknowledged. “Technology has facilitated the production of information at a far faster rate than at any time in the past,” he said. “But in the information economy, it remains up to us to organize and use that information in ways that improve the quality of decision making.”

Economists agree that the intellectual terrain they navigate is much more uncertain and confused these days. Greenspan’s remarks underscored that uncertainty.

The conventional wisdom, for example, formerly held that unemployment couldn’t fall below 6% without triggering a burst of inflation. But it has remained steady at far below 5% for a protracted period, and there is no sign of rising prices.

“We have to admit we know less about things than we thought we did,” said Martin Regalia, chief economist at the U.S. Chamber of Commerce.

In the current economic climate, Regalia said, “it is surprising the economy has slowed as much as it has, yet with so few layoffs.”

The changes in financial institutions give consumers more knowledge and more opportunities to change their spending rapidly, undermining the powers at Greenspan’s disposal.

Rising real estate prices have long provided consumers a chance to enjoy profits. But previously, homeowners couldn’t cash in until they sold the house. Now, with home equity lines of credit, consumers have access to big sums of cash while living in the house. This means more money is immediately available to consumers.

Information on stock gains also has an effect. Traditional pension systems, with the money invested by corporations, could enjoy stock market gains, but individual workers did not pay attention until they retired and began collecting their monthly pension checks.

The current system emphasizes the 401(k) salary set-aside accounts, with individuals getting monthly or quarterly statements showing their retirement balances. The stock market boom often changed consumers’ outlook, sometimes making them enthusiastic spenders, said Tom Palley, deputy chief of public policy at the AFL-CIO. “You receive a statement saying that your wealth has increased, and you think that means there is less need to save, that the savings is being done by the [stock] market,” Palley said. Consumers, feeling rich, rush to spend, he said.

Greenspan acknowledged that the stock market gains have given the economy a major boost.

“No matter how one differentiates the effects on consumer spending of capital gains on stock market and housing wealth, it is clear that the massive increase in capital values over the past five years had a profound impact on output and income,” he said.

The AFL-CIO would like Greenspan to use other tools than interest rate changes to deal with the economy. Imposing new reserve requirements on banks could slow down the growth of home equity loans, or the Fed could ask mutual funds to hold more of their assets in cash to dampen stock market fluctuations, Palley said. Such steps would slow the erratic swings in consumer spending, he said.

However, the Federal Reserve does not want to take such steps. Greenspan instead is relying on a single tool of economic policy: the Fed’s power to drive interest rates.

Greenspan indicated that he is looking for more data and understanding, rather than different policy approaches. “We need far more information than we currently possess about the nature and the sources of capital gains and the interaction of these gains with credit markets and consumer behavior,” he said.

New accounting methods may provide the necessary clues, he suggested.

“As we endeavor to better understand how changes in the level and composition of wealth affect economic behavior, new accounting systems may be required to supplement those that have long served us so well,” he said.