Poor Alan Greenspan. Here the Federal Reserve Board Chairman thought he was doing the world a big favor by cutting interest rates to 5.25 percent, and the stock market promptly responds by going down. Even though most bets had the Fed sticking to a quarter-point drop in the Fed Funds rate the rate banks charge each other for overnight loans Wall Street was hoping against hope that Greenspan & Co. might go for a half-point drop.
But no dice. Actually, there's considerable debate on whether any interest rate cut was needed, given that the U.S. economy shows little sign that it really needs a pick-me-up.
And let's face it, interest rates had been coming down well before the Fed decided to act significantly under the 5.25 percent level. In fact, thanks to a boost in bond prices the newest "in" spot for nervous investors looking to exit stocks long-term government bond yields slipped under 5 percent for the first time in 31 years.
What played out last week was instructive on several levels. First and foremost, it showed that the Federal Reserve cannot be all things to all markets. Policy decisions that might work on one level will not work on others.
By keeping short-term interest rates as high as they've been, Greenspan was betting that inflation would remain his highest priority an understandable stance given the last 30 years of economic history. But it's also living in the past, because inflation has been barely a blip on the radar screen for years.
Besides, the world has become a very complicated place in the last decade, and domestic inflation is just one of many puzzle parts the Fed has to consider. By many accounts, the decision to bring down interest rates was predicated less on the domestic situation and more on fears that the current economic troubles in Asia, Russia and Brazil would spread all over the globe to the point where even the U.S. economy would become exposed.
Whatever the motivation, no one really believes that the Fed's modest action will amount to more than a Band-Aid on a bullet wound; in fact, the notion that lower U.S. interest rates can successfully stimulate the world economy is a pipe dream at best.
That's not to minimize the importance of Alan Greenspan on the global scene. As noted in this space several weeks ago, he has the stature and certainly the clout to take a leadership role in the current economic crisis. Working with Treasury Secretary Robert Rubin, officials of the International Monetary Fund and finance ministers of the G-7 nations, he can help establish some important parameters on the movement of investment money, the role of bank regulations, and even the improved monitoring of hedge funds.
None of which, however, necessarily falls under the purview of the Federal Reserve Board, per se. Its primary mission, as spelled out by Congress 20 years ago, is to maximize employment, keep prices stable and maintain moderate interest rates.
For now, no one has quite figured out where to draw the line between these traditional economic goals and the current world crisis. Or perhaps more unsettling, whether the articulation of such roles is even possible in an environment bred by confusion, contention and even chaos.
For reprint and licensing requests for this article, CLICK HERE.
Stories You May Also Be Interested In
- Greenspan Signals More Rate Increases
- FEDS--Local Fed Board Helps Set National Monetary Policy
- Greenspan Raised Interest Rates, And the Stock Market Just Yawned Show Me, Alan
- Fed Boosts Key Interest Rate
- Fed to Mull Interest Rate Increase
- Fed Mulls Interest Rate Hike
- Greenspan Says Economy on Fairly Firm Ground