The Daily Interview: Don't Blame Greenspan

As more and more analysts and pundits -- including yesterday's Daily Interview subject, Robert Froehlich -- decry Fed Chairman Alan Greenspan's decision not to cut short-term interest rates by a wider margin Tuesday, some of Greenspan's supporters are starting to rally to his defense.

Michael Boldin Economics Researcher Wharton School of Business.

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Michael Boldin, an economics researcher at the Wharton School of Business, is one of them. He thinks Wall Street was wrong to have expected a more dramatic rate cut from the Fed on Tuesday. He maintains that ensuring that the stock market keeps rising is not and should not be Greenspan's primary concern, and that both the stock market and the economy are in better shape than people realize.

TSC: A number of analysts believe that by raising interest rates from 4.75% in June 1999 to 6.5% a year later, Greenspan acted too aggressively in the absence of inflation, and that now that we are in a bear market, he should be just as aggressive in lowering rates. Why do you disagree with folks like Robert Froehlich, who said Greenspan should have given the markets a dramatic rate cut of 75 to 100 basis points ?

Boldin: Monetary policy isn't really about keeping the stock market at a certain level. Alan Greenspan's job of keeping the economy on an even keel is tough enough as it is, without putting that on the table. He's done an almost perfect job of stewarding the economy, even though we are going through a tough time right now.

It's clear that the economic problems right now are not interest-rate problems, even though that's what everybody is focusing on. The problem is a loss of consumer confidence as a result of the sagging stock market and high-tech firms' valuations becoming too high as a result of overinvesting.

TSC: But traders are looking for a dramatic catalyst to lift the economy, and even you have said that if something doesn't happen to improve consumer confidence, we may be headed for a recession. So why take issue with those traders who were simply looking for a bigger rate cut on Tuesday?

Boldin: I just don't believe that the Federal Reserve Board is responsible for providing that catalyst. That would set up a dangerous precedent. I think investors should be thanking Alan Greenspan for what he's done for the economy, instead of trying to run him out of town.

If you look at the track record of the stock market since Greenspan made his infamous "irrational exuberance" statement in December 1996, the broad market indices are still more than 50% above the levels that they were then. This translates to 12% annualized returns in the years since. You would think investors would hail Greenspan as the good shepherd of the stock market. And as far as what Greenspan is doing now, I don't think he needs to act any more swiftly because jobs are not falling apart; we see steady job growth.

TSC: The current employment figures are positive, but they could deteriorate in the coming months as future layoffs that have been announced become reality.

Boldin: If more firms get into a negative viewpoint about the economy and consumers become even more negative, we may see more job cuts. Right now if you look at the financial situation at most firms, they don't need to cut jobs because they're not making profits. It's only a small sector of the economy that's doing this. Even the auto sector, which had to cut back a little, is coming back in some ways.

So I think it's entirely possible the worst is behind us. Some stocks are still slightly overvalued, but with an average P/E ratio of 20, we are probably where we should be for broad-sector firms.

And now, with the Federal Reserve interest rate now at 5% and the short-term Treasury yield curve at 3.96%, we are in good shape because the economy has never gone into recession when the rate is below 5%, and the most important interest rates are at or below 5%. I cannot remember when the one-year Treasury yield curve was below 4%. That's an amazingly low number.

TSC: You maintain that the one-year Treasury yield curve has a greater impact on the economy than the Federal Reserve rate. Why?

Boldin: Everybody wants to focus on the federal funds rate , but that actually is a very technical market that only has about $40 billion in volume. We are talking about trillions in the Treasury market and in the money supply. The one-year Treasury bill has proven to be much more important, according to my research, in looking at both the short- and long-term health of the economy. It is now anticipating further cuts in the Federal Reserve.

Therefore, it's not important whether further cuts happen in a large 75 basis-point cut this past Tuesday or in additional cuts over the next few months. If you look at Greenspan's rate policies since the 1990s, you'll see that he's never been off from the best Federal Reserve rates by more than 100 basis points, and a 100 basis-point miss is not enough to push the U.S. economy into recession. The magnitude by which he has been off has been reasonable.