(March 21) – “The Federal Reserve is all but certain to raise its benchmark interest rate by another quarter of a percentage point on Tuesday, to 6 percent. That much Alan Greenspan has made clear in his public statements. What is less clear is the central bank chairman’s thinking about the forces that are driving him to tighten monetary policy,” writes Richard Stevenson in today’s New York Times.
In Congressional testimony and speeches, Mr. Greenspan has left economists and investors scratching their heads by seeming to assert that the increase in the growth rate of productivity — almost universally considered to be the most unambiguously positive development in the nation’s recent economic history — is now to be blamed for causing inflation. And although the riches generated by Wall Street’s bull run have been reaped by relatively few people, Mr. Greenspan seems to have concluded that the stock market is the primary channel through which inflation is being transmitted throughout the economy. Never mind that even Mr. Greenspan cannot find much inflation.
It may be months or years before it will be possible to judge whether Mr. Greenspan is doing the right thing for the right reasons. Some economists think the Fed chairman is taking a straightforward situation — an economy that is growing too fast for its own good — and overanalyzing the causes. Others think Mr. Greenspan is creating an elaborate justification for raising rates to mask a desire to bring down the stock market. And it is possible that Mr. Greenspan is deliberately sowing confusion to keep investors off balance and avoid a further run-up in stock prices.
The markets seem to have picked up his basic message that Tuesday’s rate increase is unlikely to be the last, given the persistent strength of the economy. And while aspects of his thinking remain veiled, interviews with economists and Fed officials, as well as a close reading of Mr. Greenspan’s statements over the last few months, help to bring his views into focus on critical issues including productivity, the stock market and the scale of the changes the economy is undergoing.
Yes, Mr. Greenspan sees the surge in productivity growth as a root cause of the imbalances that threaten the long expansion. By driving up profit expectations, productivity growth drives stock prices higher, leaving investors feeling rich and willing to spend. In the short run, at least, the growth in demand exceeds the growth in the economy’s ability to provide offsetting increases in supply, creating the potential for inflationary bottlenecks. But Mr. Greenspan has also tried to point out that the same productivity-driven forces that send stock prices and consumer spending up have a countervailing effect that helps dampen the economy.
Because increased productivity implies higher rates of return on investment, productivity improvements lead to a rise in demand for capital to take advantage of those returns. That in turn puts upward pressure on interest rates in the financial markets, slowing growth.