Greenspan and Interest Rates
May 26, 2000

Is it possible that Mr. Greenspan's popularity has dimmed?

For long, the redoubtable Fed chairman could do no wrong. His reputation was arguably cemented in 1987, when following the October stock market crash, he successfully used monetary policy to steer the economy away from what appeared to be certain disaster.

In 1992, Greenspan raised interest rates to combat rising inflation. Unfortunately for then-President Bush who was seeking a second term, the policy led to an economic slowdown which, in Bush = s eyes, doomed his candidacy. But the economy = s torpor proved to be fleeting B following Clinton = s ascent to the Presidency, the economy entered a period of remarkable growth. This period of expansion, the longest on record, continues to this day, and shows little sign of abating despite a number of interest-rate hikes by the Fed in recent months.

In May, Greenspan raised interest rates for the sixth time since June 1999. This time, however, the increase was 0.5 percent, a marked change from the 0.25 percent hikes in the recent past.

Clearly, the Fed has decided that modest increments are not sufficient to combat the scourge of inflation. The unemployment rate has fallen below 4 percent, an astonishingly low level at which wages have started to rise perceptibly. More troubling to the Fed, the increase in wages has been in excess of productivity gains which does not augur well for price stability.

To make matters worse, the price of oil, after falling to about $25 a barrel, has risen once again to $30, increasing the likelihood that firms will start raising the prices of their products to counter the additional energy costs involved in the production and distribution of goods.

Then there is the stock market. Until recently, the rapid rise in the prices of stocks had caused households = wealth to increase, leading to a surge in spending. Coming at a time of full employment, the increased spending on goods would tend to exacerbate inflationary pressures in the economy.

And the data, finally, had begun to reveal the presence of incipient inflation. The consumer price index in April was 3 percent higher than its value 12 months ago. Not a steep increase, admittedly, but enough to cause concerns at the inflation-wary Fed.

By raising interest rates, the Fed intends to restrain consumer spending on big-ticket items such as houses, cars and the like. The reduction in aggregate spending, Greenspan hopes, will prove sufficient to keep inflation in check.

But the unbroken series of interest-rate hikes, with the promise of more to come, has caused widespread dismay. Investors, watching the stock market = s decline with trepidation, blame Greenspan for raising rates at an inopportune time. Home buyers, confronted by the prospect of significantly larger mortgage payments, are not pleased. Firms that sell products on credit, such as makers of automobiles and big-screen TVs, are nervous about the diminished exuberance of consumers. (Even yours truly, who has written approvingly of the Fed chief in the past, was recently called a Greenspan Goon by a philosopher friend.)

Al Gore must be watching all this unfold with some consternation. Eight years ago, during another election year, higher rates had been accompanied by an economic slowdown -- and a defeat for the incumbent party's candidate. With each interest-rate hike, Gore must be praying that history will fail to repeat itself in 2000.