Greenspan Opposes Shifts at Fed but Faces Challenges

WASHINGTON â€”  Without any fanfare, the changing of the guard at the Federal Reserve Board is taking place. And that’s just the way the new chairman, Alan S. Greenspan, and the outgoing head, Paul A. Volcker, want it.

Greenspan, a soft-spoken conservative economist, sees little need for a shift in Fed monetary policies and is moving cautiously in promoting his own more free-market views on deregulating the nation’s banking system. And Volcker, the most important figure in U.S. economic policy over the last eight years, seems almost eager to fade from the limelight.

But the situation may not be as tranquil as it seems. Greenspan, along with managing the gradual transfer of immense power that formally began on Aug. 11, faces some crucial challenges in the months ahead.

“Since 1982, we haven’t had any really objective way to conduct monetary policy,� said Ira P. Kaminow, chief economist for the Government Research Corp., a private consulting firm here. “We’ve been on a Volcker standard in which the Fed, flying on instincts, intuition and a little luck, has had a great deal of success. The fundamental question mark is whether Greenspan, who perhaps will have to roll the dice even more often than Volcker, can have the same sort of success.�

For starters, the faint warning signals of renewed inflation are on the horizon, and Wall Street will be watching closely to see how Greenspan responds.

Economists believe he may have to allow short-term interest rates to rise modestly if he wants to curb inflation by stabilizing the value of the dollar. That would reassure the financial community, but it could instantly plunge him into the political maelstrom over the nation’s stubborn trade deficit. Higher rates would be unpopular in Congress and would inflame those who think U.S. currency should fall further, despite the inflation threat, to help reduce the trade imbalance.

“The anxiety in the markets is that Greenspan would be inclined to let the dollar slide for trade reasons,� contended Alan K. Reynolds, chief economist at the “supply-side� consulting firm Polyconomics Inc. in Morristown, N.J., who opposed Greenspan’s selection as Fed chairman. “And there are a lot of pressures in Washington to do just that.�

Inside the Fed, Greenspan will have to see if it is possible to devise more effective methods for anticipating future economic trends. In recent years, policy-makers have found that traditional guidelines are no longer very useful in predicting inflation and economic growth. That has made it all the more difficult to adjust monetary policy accordingly to maintain the health of the economy.

Array of Measures

After abandoning in 1982 its dependence on the money supply as a chief barometer, the Fed has fallen back on a shifting array of measures, none of which have proved satisfactory on their own.

“I just don’t think there is any easy way or single rule to stabilize the value of the currency, which is our paramount objective,� said Gary Stern, president of the Minneapolis Federal Reserve Bank and a current member of the Fed’s Open Market Committee that sets monetary policy on roughly a month-to-month basis. “You have to look at the fundamentals of the situation, and it makes a hell of a difference what the reasons are behind the changes� in the signals’ readings.

By default, the Fed appears to be creeping toward far more reliance on the long-term bond market itself to indicate when it should alter its monetary stance--instead of the money supply, commodity prices, the rate of economic growth or labor costs that various camps of economists advocate as the best guidelines.

Too Loose or Too Tight

The chief problem with following the bond market, which moves in the opposite direction from interest rates, is that it is sometimes difficult to determine whether long-term interest rates are rising because the Fed is being too loose with the money supply, which fans the flames of inflation, or because it is being too tight, draining an excessive amount of funds from the banking system.

Despite the difficulty in analyzing the bond market, the Fed still may have little choice but to react to it. Because bond investors are now much quicker to sell when they sense any sign of inflation, raising long-term interest rates, the Fed is under pressure to act quickly to calm the fears and bring the long-term rates down.

“We don’t have a lot of leeway because of the bond market and the foreign exchange markets,� Stern explained. “They are vigilantes when it comes to inflation prospects.�

In this task and others, Greenspan “will have to develop his own approach,� Kaminow said. “If he stumbles, whether through incompetence or just bad luck, he will dig himself a big credibility hole that will be hard to get out of.�

Inflation Is First Test

Many analysts believe inflation will be the first test of the Greenspan era. A growing number are beginning to worry more about its potential threat to economic health than the dangers that the relatively weak economic growth of the last three years will evaporate into a recession.

“If you look at the financial markets, they are telling you something important--they aren’t sure you can trust the Federal Reserve to maintain the purchasing power of the dollar over time,� said Charles W. Kadlec, a vice president of J & W. Seligman & Co., a New York investment manager.

“I think everything is conspiring together to create somewhat more inflation,� said Jerry Jordan, chief economist at First Interstate Bank in Los Angeles and a former economic adviser to President Reagan.

“For the Administration, a monetary tax increase--inflation--seems to be preferable to an explicit tax hike. And it looks like the past monetary explosion around the world could be about to produce a strong burst of growth� in inflation here, Jordan said.

Greenspan, whose move into the chairman’s office at the Fed has been held up briefly while it is being repainted, is just beginning the process of putting his own stamp on the institution. A model of the cautious, relatively pessimistic economist who fits well with the image of the “dismal science,� he thinks that in most circumstances the Fed should strive for stability by generally following the dictates of markets rather than trying to lead them.

Making His Mark Early

But he may not enjoy that luxury for long. “Every strong Fed chairman has made his mark early,� said Jordan. “Some incipient crisis will develop and I think Greenspan will come through fine when he is tested.�

After eight years of Volcker, who was crucial to guiding the U.S. economy through one of the most turbulent economic periods in its history, Greenspan recognizes just how tough it will be to match the record of his predecessor.

Volcker, though, is doing his best not to upstage his successor. While he has been offering Greenspan his private advice during a month-long transition that is expected to end around Labor Day, Volcker said nothing at the swearing-in ceremony for Greenspan earlier this month.

And the departing central banker, who masked his painful shyness behind an imposing public persona, admitted to friends recently that he was disturbed by a quite favorable upcoming biography by Chicago Tribune reporter Bill Neikirk because it is too personal and focuses too much attention on him rather than the Fed.

For his part, Greenspan offered an ironic comment after he was sworn in by Reagan, suggesting he expects plenty of economic challenges during his term.

“Perhaps I should thank in advance the creators of all those events that will make the next four years easygoing--inflation which always stays put, a stock market which is always a bull, a dollar which is always stable, interest rates which stay low and employment which stays high,� Greenspan said. “But most assuredly, I would be thankful to those who have the capability of repealing the laws of arithmetic which would make all of the foregoing possible.�