Maybe it's time for
Alan Greenspan to sit down with
for a discussion on alternative strategies for monetary policy.
In 1994, when the
Fed adopted a new approach to making and communicating adjustments in its policy, by confining such changes to regularly scheduled meetings of the
Federal Open Market Committee and increasing its efforts to explain the decision process to general audiences, it seemed like a big step forward in demystifying this important government function.
But no good deed goes unpunished. By the Law of Unintended Consequences, Fed officials, and investors, should have expected that these adjustments would alter the way the economy and financial markets would respond to the decisions of the now less-secret temple.
Six tightening moves totaling 175 basis points have so far failed to make much of a dent in an onrushing U.S. economic juggernaut led by runaway consumption and investment spending. The U.S. private sector remains on a tear, partially as a lagged result of earlier easing moves by the Fed and other central banks. It's not clear when the recent efforts at braking the runaway train will take effect, or what that effect will be. Through speeches, testimony, press releases and informal remarks, Fed officials have expressed their concern that early inflationary conditions prevail today and, since early inflation is like early cancer, the Fed has now made clear its intent to nip the process in the bud, if it can.
Everybody knows that. The Fed's post-1994 communications doctrine has enabled the average investor to follow the Fed in a manner that previously only a specialized high priesthood could do. But since everybody knows, and prepares for, what the monetary authority will do, the impact of its actions is diminished. It is not tightening simply to go through the motions, so it may have to do more to achieve its intended effect. If doing what is expected is poor tactics, as is the case in many games -- and the interaction of markets and monetary authority is one of the great games of all time -- then doing the unexpected may produce a more effective bang for the policy buck.
I believe we can count on Fed officials eventually to be effective in slowing the economy and addressing the inflationary imbalances of private sector debt creation and current account deficit that now so publicly trouble them. But the longer they wait to take effective action, the worse will be the collateral damage. A stitch in time saves nine, and doing precisely what the other guy expects -- in a card game, a prizefight, or in monetary policy -- is at best a waste of time. And time is of the essence in early inflationary conditions, as it is in the early stages of other progressive diseases.
The point here is about process control: What is the best way to achieve the Fed's stated purpose of slowing this unbalanced juggernaut of an economy? If I extrapolate the current game plan, I see the Fed and the markets spending the next two years or so going through a minuet of anticipation -- selloff -- tightening -- rally, while economic momentum powers through to the later stages of the inflationary process. In the late stages there is all hell to pay. I assume everyone would prefer to dodge that outcome.
What is the best way to avoid it? Not the current strategy. The current approach will subject the markets to a prolonged period of constant screeching, friction and heat of monetary brakes as they drag with limited effect against the trends in place. An alternative approach, a massively effective -- and by definition unexpected -- punch in the economy's solar plexus will knock the wind out of the complacent optimism that now drives consumption and investment spending. And financing decisions. And market behavior.
If that result is achieved, the Fed can switch back almost immediately to an accommodative stance, quickly chopping down the spike in its target rate that shocked the economy off the inflationary track it now appears to be on. The markets and the economy will spend much less time coping with the effects of monetary restraint if that restraint is applied in the fashion of the Powell Doctrine for military engagement: Apply overwhelming force, then quickly get out of there.
If people, both at home and at work, are more aware of the downside and less easy in their assumptions about the upside, their borrowing, spending and investment behaviors may produce a better modulated and more balanced economic advance.
Process control. Rolling downhill and gathering momentum, do you ride the brakes? Or do you use them only occasionally, but forcefully, to maintain safe speed? Maybe, in the case of monetary policy, the former approach is usually preferable as the lower risk strategy. But it's not no-risk, it's merely a different-risk strategy. What might happen if, as a result of the many changes that have taken place in the economy and markets since the Fed changed its rules, the brakes don't grab in the way they once did? "Gradualism" has burned out the brakes at least once before, during the late 1970s term of G. William Miller at the Fed's helm.
If the brakes aren't working after, say, a dozen tightening moves -- as they don't seem to be working after a half-dozen -- we can count on the Fed to switch strategies. By then, the collateral damage of achieving a noninflationary growth path will be much worse.
Plodding predictability may not be any more advantageous to achieving the objectives of monetary officials than it is to those of military leaders. Surprise has been important in the past in potentiating the effect of monetary policy changes. It continues to be an element in foreign-exchange interventions.
It's not nice to surprise mother nature, and surprise won't be well received by the markets, Congress or the American public. But as former chairman William McChesney Martin observed, it's the role of the Fed to take away the punch bowl when the party gets rowdy. In disciplining a boisterous economy, in the economy's own long-term best interests, Greenspan & Co. will have to endure slings and arrows from the right side of the aisle, from those who believe he should let the good times roll. These will supplement the traditional complaints from the left side, that his medicine will negatively affect the working person.
Everybody loved good ol' Al when he was in easy money mode -- but nobody loves the repo man.
If the Fed is as concerned as it indicates that it is about the implications of today's economic momentum and imbalances, it's time to take effective action to head off the potential outcome of current trends. By definition, the markets cannot expect a surprise -- but we should not be dumbfounded if the Fed stops meeting and starts beating market expectations.
It's about process control. It's about timing and gamesmanship. It's about trying to preserve the gains that so many of us have achieved in the 1990s and extend them deep into the current decade.
Jim Griffin is the chief strategist at Hartford, Conn.-based Aeltus Investment Management, which manages institutional investment accounts and acts as adviser to the Aetna Mutual Funds. His commentary on the financial markets is based upon information thought to be reliable and is not meant as investment advice. While Griffin cannot provide investment advice or recommendations, he invites you to comment on his column at