Alan Greenspan Finds Enlightenment
As has become usual, Alan Greenspan's speech last Friday at the gathering of
the world's central bankers in Jackson Hole, Wyo., has been ardently
scrutinized by both the financial press and investors anxious to figure out
whether the Federal Reserve is planning to raise interest rates anytime soon.
What's occasioned the most notice, fittingly enough, was Greenspan's argument
that central bankers needed to pay attention to asset prices--like, oh, the
stock market--in addition to the prices of normal goods and services if the
bankers want to have a handle on what may drive inflation in the future.
Some commentators have also remarked that Greenspan's speech, far from being
"a stark warning," as Reuters termed it, was a tempered acknowledgement that
even central bankers have a hard time figuring out when markets are overvalued.
That, in turn, suggests that Greenspan understands now that his "irrational
exuberance" speech of three years ago was precisely what it was, one person's
attempt to outthink a market that it is very difficult to outthink. What's
especially curious about this is that one would have thought this was a
conclusion a supposedly ardent devotee of the free market would have reached a
long time ago.
Greenspan, of course, has never ascribed to himself (at least not in
public--who knows what he thinks as he sits contentedly in his bathtub) the
level of wisdom and farsightedness that the media have come to grant him. His
remarks are typically shrouded and hedged, and though it is of course the job
of the Fed to restrain inflation and promote economic growth, which requires
him to make at least educated guesses about the future, Greenspan generally
does seem well aware of the limits of his own knowledge.
This is as it should be, since a fundamental principle of a free-market
economy is that the market knows more than any individual within it. But
Greenspan's comments on the stock market--including, but not limited to, the
"irrational exuberance" speech--have been oddly dismissive of that principle,
and oddly certain that something like a bubble was in place. In his speech on
Friday, though, Greenspan acknowledged that market prices are determined by
"millions of investors, many of whom are highly knowledgeable about the
prospects for the specific companies" that make up the market indices.
Even more important, perhaps, he suggested that the unprecedented rise in
stock prices over the past five years in particular was due to a substantive
change in the way the market discounted the future. Obviously, we don't know
exactly what that change is, but it does seem as if stock-market investors
today think stocks are less risky than they once did, believe that inflation is
not a long-term threat, and believe that the economic dominance of American
corporations--and the extraordinary recent growth in corporate profits--can be
extended for a long period of time. Put those things together, and you end up
with a strong case for higher stock prices. Any or all of those assumptions may
be wrong, of course, but in pointing to the discounting process in particular
Greenspan did something important, which was get away from the simple idea of
"irrationality" and move toward a more rigorous analysis of what's been
happening.
The other thing Greenspan's speech signaled is that the Fed is not
going to jack up interest rates just to prick a stock-market bubble, imagined
or not. In emphasizing that the best, and clearest, use of monetary policy is
to revive an economy in the wake of a deflationary crash by cutting
rates, Greenspan seemed to acknowledge that the Fed was ill-equipped to be in
the business of figuring out what stock prices should be. The point of watching
asset prices for the Fed is to understand whether the wealth effect is helping
rev the economy beyond sustainable growth. It's not to scold investors. We may
be heading for a crash (though I don't think so). But if we are, we'll get
there all on our own. Greenspan won't be giving us a push.
