Published September 02, 2002
JACKSON HOLE, Wyo – Federal Reserve Chairman Alan Greenspan Friday defended the central bank's lack of action during the ill-fated 1990s stock market boom, saying there was little the central bank could do to identify and fight emerging asset bubbles.
Speaking to an annual symposium of top global central bankers, the Fed chief suggested that to wring out the stock market excesses at the end of the 1990s, the Fed might have had to raise rates to recession-inducing levels.
Greenspan said there was not a reliable enough guide to allow a central bank to safely and slowly deflate a speculative surge in prices. The bursting of the 1990s stock bubble erased trillions of dollars in wealth, prompting criticism that the powerful Fed chief should have done more to prevent it.
"It is by no means evident to us that we currently have -- or will be able to find -- a measure of equity premiums or related indicators that convincingly presage an emerging bubble," Greenspan told bankers attending a meeting sponsored by the Kansas City Federal Reserve at this Rocky Mountain resort.
BUBBLES HARD TO DEFLATE
"Short of such a measure, I find it difficult to conceive of an adequate degree of central bank certainty to justify the scale of preemptive tightening that would likely be necessary to neutralize a bubble," Greenspan said.
The Fed chief in December 1996 famously wondered aloud if the stock market had a case of "irrational exuberance" but he later abandoned efforts to talk down share prices and they bounded almost unstoppably higher until spring 2000.
Greenspan said on Friday that policymakers are still trying to understand developments in the economy and financial markets since the 1990s and said the Fed has been studying the issue of asset bubbles -- in which prices for such assets as stocks or commodities shoot up to unsustainable levels.
Some economists suggested Greenspan may have had his eye on other recent events, such as the boom in real estate in the United States.
"The entire subtext here is directed at housing prices," said former New York Fed research director Steve Cecchetti. "I think the problem now is (the Fed is) coming under pressure because of housing prices," said Cecchetti, who says he is uncertain whether there is a housing bubble.
Despite worries in some quarters that the upswing in the housing market may amount to a bubble, Greenspan has repeatedly ruled this out, saying the market is regional rather than national and not suited to the kind of swift buying and selling that leads to unsustainable surges.
Of the 1990s stock market surge, some critics have said Greenspan should have used his always powerful rhetoric, interest rate hikes or even tighter margin requirements for buying stocks to help let air out of the bubble sooner and less painfully.
But the Fed chairman has indicated in the past that he did not believe it was the Fed's job to second-guess the judgments of private investors about the appropriate value of stocks.
In addition, Greenspan said, "it was difficult to definitively identify a bubble until after the fact -- that is, when its bursting confirmed its existence."
The Fed chief gave no hints about current economic policy to financial markets, which had awaited his comments keenly, and they as a result showed no price reaction.
STILL SOME CRITICS
Financial market participants questioned Greenspan's contention there was nothing that the Fed could do to tamp down soaring equity prices before they crashed.
"In the late 1990s, the Fed kept emphasizing that we were in a tech-driven, productivity-led investment boom," said economist James Padinha of Arnhold and S. Bleichroeder Inc. in Los Angeles, adding that it was clear the cost of capital should have been rising more rapidly along with returns.
Instead, the Fed kept rates steady until mid-1999. "We'll never know if raising rates would have prevented a bubble," Padinha said, "But to say it couldn't have done anything is kind of ridiculous."
Greenspan noted that, from mid-1999 through May 2000, the Fed raised its bellwether federal funds rate by 1.5 percentage points but it failed to cool soaring stock prices.
"Such data suggest that nothing short of a sharp increase in short-term rates that engenders a significant economic retrenchment is sufficient to check a nascent bubble," he said. "The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion."
The Fed actually raised U.S. interest rates six times beginning in June 1999 and ending in May 2000, then held them steady until a surprise half-percentage-point cut in January 2001 that initiated a series of 11 rate reductions as the economy weakened.