U.S. Federal Reserve Chairman Alan Greenspan said Saturday that policymakers have been proven correct in their decision not to try to prick a 1990s stock-market bubble that subsequently broke on its own.
"There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble's consequences rather than the bubble itself has been successful," Greenspan told the annual meeting of the American Economic Association in San Diego, Calif.
Greenspan cited the "exceptionally" mild nature of the eight-month 2001 recession despite a series of shocks to the economy that included plunging stock prices, the Sept. 11 attacks, corporate scandals and wars in Afghanistan and Iraq.
In defending the Fed's tactics, Greenspan said if the Fed had stepped in to curb stock prices by raising rates, it might have done damage to the entire economy in the process. Stock prices collapsed in early 2000, wiping out trillions of dollars of investors' wealth.
Now in his 17th year as chief of the U.S. central bank, Greenspan stressed that sound policymaking requires judgment and can be helped, but not fully guided, through simple rules. He said the U.S. economy's resilience and ability to quickly adapt had also increased its ability to weather adversity.
Claims policy credit
"Much of the ability of the U.S. economy to absorb these sequences of shocks resulted from notably improved structural flexibility," Greenspan said in a relatively academic address. "But highly aggressive monetary ease was doubtless also a significant contributor to stability."
He said the idea that the Fed could have brought the 1990s stock bubble to a gentle decline by ratcheting interest rates up -- as some critics have suggested it should have done -- "is almost surely an illusion."
In a question-and-answer period later, Greenspan said policymakers could have halted the rise in stock prices by hiking interest rates until it happened, "but it would bring the whole economy down with it."
The Fed chief made no comment about current U.S. economic conditions and offered no hint about how soon U.S. central bank policymakers might move interest rates up from 45-year lows in the face of mounting evidence of a broad-based pickup in U.S. economic activity.
Building on a theme he addressed last August at a Jackson Hole, Wyo., conference, Greenspan said policymakers had to choose between a variety of possible events in setting a course for interest rates.
"A central bank needs to consider not only the most likely future path for the economy but also the distribution of possible outcomes about that path," he said.
He said such judgment was a factor in the Fed's decision to take a low interest-rates stance to limit the risk of deflation, a potentially dangerous fall in consumer prices, even though such an outcome did not appear to be in the cards.
Ease if must
"Such a cost-benefit analysis is an ongoing part of monetary policy decision-making and causes us to tip more toward monetary ease when a contractionary event ... seems especially likely or the costs associated with it seem especially high," he said.
The Fed lowered interest rates by a whopping 4-3/4 percentage points in 2001 after the stock market's collapse and the Sept. 11 attacks, and by another three-quarters of a percentage point by the end of June 2003 to the current 1 percent, the lowest rate since 1958.
In a reference to inflation-targeting regimes used by some other countries' central banks, though not the Federal Reserve, Greenspan suggested they could not replace a solid record of sound policy guided by judgment.
"As yet unresolved is whether the mere announcement that a central bank intends to engage in inflation targeting increases the credibility of the central bank's inclination to maintain price stability and, hence, assists in the anchoring of inflation expectations," he said.
In a separate address, Fed Governor Ben Bernanke -- who has argued in the past that it would be useful for the Fed to set a specific inflation target -- said it might make the economy more efficient.
"A potential advantage of having an explicit objective for inflation in particular is that it may help to anchor the public's expectations," Bernanke said. Many economists say unswerving expectations among the public about future inflation helps contain and control the pace of price rises.
In response to a question, Bernanke said an abundance of slack in the labor market, where upward of 2-1/2 million factory workers have lost their jobs in the past three years, was helping keep a damper on price rises.
"On that basis I think that inflation is going to remain contained for some time," Bernanke said. Muted inflation may deter the Fed longer from raising rates, despite signs a broad-based economic recovery is taking shape.
