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The Greenspan Effect

To Fight Rising Prices, Fed Nominee May Need New Weapons

November 4, 2005

By LOUIS UCHITELLE

Early in his tenure as chairman of the Federal Reserve, Alan Greenspandeclared that the risk of too much inflation was so considerable that he would "err more on the side of restrictiveness than of stimulus."

(51) . At his very first meeting, in August 1987, Mr. Greenspan established his inflation-fighting credentials by pushing up short-term interest rates in response to only a modest rise in consumer prices, a move that contributed to the stock market crash just two months (52) .

Ben S. Bernanke, who is expected to take over at the Fed in February, will almost certainly echo Mr. Greenspan's step, raising rates at his first meeting next year, in part to demonstrate his commitment, too, to   53  inflation under

control. But for all the similarities of their actions upon taking office, Mr. Bernanke faces a fundamentally different set of circumstances than those that Mr. Greenspan confronted 18 years ago.

"Inflation is clearly not right around the corner like it used to be," said Edward M. Gramlich, until recently a Fed governor and now interim provost at the University of Michigan. "The relationships are different, and Mr. Bernanke is going to have to figure them out."

Perhaps the biggest differences are the rise of global production, as well as much easier access to capital, particularly from abroad. Adding to the change is labor's weaker bargaining power. These factors have combined to greatly diminish the force of old-style inflation in which demand outran supply, pushing prices ever higher, and wages, too, until the Fed put the brakes on the economy.

Instead, a new style of inflation has emerged as one of the principal threats to the economy. It is evident in the stock market bubble of the late 1990's and in surging home prices in this decade. This asset price spiral, as it is called, has proved much more resistant to the Fed's standard interest rate tool than traditional inflation.

Mr. Bernanke, for his part, is known as an advocate of inflation targeting, a technique for adjusting interest rates with the aim of keeping traditional inflationary pressures within a limited range. He has also asserted, like Mr. Greenspan, that he does not intend to use interest rates prematurely to puncture an asset bubble. But he has signaled a readiness to use a different  set of tools to fight the new inflation,  60  .

        

(Adapted from The New York Times)

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