(December 6) – “I am not a Grinch. Thus spake Alan Greenspan yesterday at a meeting of community bankers in New York City,” writes Gretchen Morgenson in today’s Wall Street Journal.

“The chairman of the Federal Reserve Board signaled that because the economy is showing signs of a serious slowdown, he is prepared to change interest rate policy from an inclination to increase rates to a far preferable predilection to cut them.”

“Investors exulted at the news, sending stocks into the stratosphere. The Nasdaq composite index, which at Monday’s close had fallen 48 percent from its March high, surged 274.05 points, or 10.5 percent, its biggest one-day jump, to 2,889.80. The Dow Jones industrial average climbed 338.62 points, or 3.2 percent, to 10,898.72. Prices of Treasury bonds also soared, and their yields fell, as investors bought securities that would benefit from declining interest rates.”

” ‘In periods of transition from unsustainable to more modest rates of growth, an economy is obviously at increased risk of untoward events that would be readily absorbed in a period of boom,’ Mr. Greenspan said. Nodding to the market turmoil of recent months, he added: ‘In an economy that already has lost some momentum, one must remain alert to the possibility that greater caution and weakening asset values in financial markets could signal or precipitate an excessive softening in household and business spending.’ “

“Translation: Even though labor markets remain drum-tight, Mr. Greenspan will cut rates to avoid the chilling effect on consumer spending and capital expenditures by businesses that a declining stock market may bring.”

“Mr. Greenspan’s comments came just two weeks before the next meeting of interest rate policy makers, on Dec. 19. The Fed chairman’s speech makes clear that while it was once true that the economy drove the stock market, today, with households supplanting their savings accounts with shares, the stock market is very much in the driver’s seat of the economy.”

“But even as stock and bond investors celebrated yesterday, troubling questions remained. Can Mr. Greenspan avert a recession or even a hard economic landing with a couple of interest rate cuts? Indeed, how much control do his interest rate levers give him over future economic performance in the United States?”

” ‘They are sending a message that they see the weakness and they are responding to it,’ said Ed McKelvey, a senior economist at Goldman, Sachs. ‘Certainly the Fed can play a useful role in shoring up confidence through a policy move it might take. But it’s not like it’s going to affect the cost of credit a whole lot. ‘ “

“Although Mr. Greenspan has been credited with steering the economy to its longest expansion on an astute management of interest rate policy, the instruments he has to ward off a recession are relatively blunt ones. Cutting rates by a quarter or half of a percentage point in the first six months of 2001, which is what many economists are now expecting, can only achieve so much. For instance, companies of questionable financial strength must now pay 16 percent annually or more to attract capital from lenders. It will take more than a one-half point cut to reduce these companies’ borrowing costs.”

“‘ The numbers coming out of the economy this quarter and next are going to be modest numbers,’ said Henry Kaufman, the Wall Street economist and author. ‘It is going to require more than a one-quarter point move by the Fed to bring back some momentum to the economy.’ “