Markets May Have Misread Greenspan

Millions of investors pumped money into stocks last Tuesday on the supposition that Federal Reserve Chairman Alan Greenspan had hinted at lower interest rates.

The market scored some of its best one-day point gains in history.

Economist Alan Meltzer says these investors are all wrong.

What Mr. Greenspan actually said, maintains the Carnegie Mellon University professor, was that the Fed has moved to a neutral monetary policy stance from the bias toward a tighter policy it has had since last spring. So a cut in interest rates is now as likely as a raise in rates.

Fed policy, of course, is of interest not only to investors but to consumers thinking of car loans, mortgages, or other debts.

Greenspan also reaffirmed that since the Fed is the "lender of last resort," it would not allow the nation's economy or financial system to collapse. But that's not new, the Pittsburgh economist notes.

As usual, Greenspan spoke in "Fed-speak," with words that are ambiguous.

Mr. Meltzer has a special status as a Fed-watcher. He has been studying monetary policy since 1961. He ranks up there in reputation in the academic community with Nobel Prize-winning economist Milton Friedman as an expert in monetary affairs.

He is also founder and head of the Shadow Open Market Committee (SOMC), a group of academic and business economists that meet semiannually to comment on current monetary policies and propose alternatives.

That group is influential. Its views usually get press coverage. Two former members are today presidents of Fed branches - Jerry Jordan in Cleveland and William Poole in St. Louis. They thus help make monetary policy.

The SOMC, currently six economists-strong, holds a meeting in Washington today. It is the 25th anniversary of its first meeting, held in New York. This writer covered that session.

At that time, SOMC policies were economic heresy. Its "monetarist" members regarded growth in the nation's money supply as more important than interest rates in determining inflation and the business cycle.

Meltzer still holds that view.

The Fed did actually launch a monetarist policy in 1979 under Paul Volcker as a cure to double-digit inflation. It worked, though at the cost of the sharp 1981-82 recession.

Fed policymakers don't follow a strict monetarist policy today. Their prime instrument of policy is short-term interest rates. But money is far from forgotten, as Greenspan has pointed out a few times this year.

Indeed, many central banks around the globe have taken some monetarist prescriptions to heart. They will, for instance, set an inflation target and aim for it by watching money growth.

Some other SOMC suggestions have been picked up by the Fed. For instance, it now announces policy decisions at the end of each policymaking session instead of after a long delay.

"It has been helpful, not harmful," says Meltzer.

Though full of praise for Greenspan, Meltzer thinks the Fed should have raised interest rates awhile back. That's not a popular view.

"All this talk about the world collapsing is overdone," Meltzer says. "We have the making of a crisis, not a crisis itself." He sees talk of deflation as "inconsistent with the facts."

Meltzer's favorite measure of money is growing at a 6 percent rate. That, he says, will continue growth in output and boost inflation from 2.5 percent now to 3 percent next year.

A relatively stern Fed policy, Meltzer says, has led to 16 years of growth, interrupted only by the mild 1990-91 recession. "All that has been achieved with declining inflation," he notes. "Inflation benefits few people."

But the number of economists calling for the Fed to cut interest rates has been multiplying. Richard Hokenson of Donaldson, Lufkin & Jenrette, a New York investment house, says a cut will be necessary to stabilize the rest of the world. Real rates - after subtracting inflation - are "too high."

Mr. Hokenson predicts a cut of half a percentage point when Fed policymakers meet Sept. 29, and more later.