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JACKSON HOLE, Wyo. (CNN/Money) -
Day One of the Jackson Hole Federal Reserve conference and so far we have heard from Alan Greenspan on the past and future of monetary policy.
A few veiled warnings. Stock buyers and homeowners, and in fact investors of all kinds, should not forget that today's elevated prices may not be a permanent feature of the economic landscape. And there are the folks trying to fan the flames of trade protectionism -- in Greenspan's view, not a good thing.
But for the most part he sounds like a man who is confident that his 18 years at the helm have helped guide the Fed to a point where his successor will be able to carry on and deal with whatever risks come down the pike.
Looking to the past, Greenspan says the Fed has evolved away from trying to rely on one single variable to guide policy changes. Anyone who's been around for awhile remembers the reliance on money supply back in the late '70s and early '80s as the supposed key to determining when it was time to raise or lower interest rates -- e.g. too much money could cause inflation so that meant hike rates.
Today Mr. G. told us basically what we all know if we have been paying any attention at all. There is no one reliable guide anymore -- maybe there never was --and so now policy-makers must look at a wide array of economic and financial statistics to figure out what is going on with growth, inflation, and the markets, and then decide what to do with short-term rates, the Fed's main instrument of monetary policy.
What is all boils down to, he says, is "risk management." That means the Fed's No. 1 objective should be to prevent an event with potentially severe consequences even if it's unlikely.
The example he gives is the Fed's worry in summer 2003 that a drop in inflation could turn into outright deflation -- when prices fall, hurting businesses and consumer alike.
He says the Fed viewed the probability of deflation as small but "because the implications for the economy were so dire should that scenario play out, we chose to counter it with unusually low interest rates."
Looking ahead, Greenspan is focusing on "balance sheet" considerations, saying Fed policy must deal in greater detail with these changes than it has in the past. That's because the central bank's forecasts and interest rates changes are becoming increasingly driven by changes in asset prices and the various kinds of financial instruments that finance them.
He goes on to note that the wealth has risen sharply relative to income driven by rising prices for equities and -- the big one -- houses. Will this last? Greenspan talks about how investors seem to see less risk in these investments and are willing to project this stability into the future.
Greenspan says that increases in asset values may seem permanent and may indeed be in part due to the increased flexibility and resiliency of the U.S. economy. But, he warns, what investors see "as newly abundant liquidity can readily disappear."
Now the Fed chief is certainly making a broad statement about people's tendency -- businesses, traders, homeowners -- to believe that whatever they see in the present they tend to predict in to the future. And he is also reminding anyone who will listen that today's hot housing market or bull market in stocks can suddenly disappear.
But this is no warning of an imminent bursting of bubbles -- far from it.
Greenspan is clearly worried that rising trade protectionism and a failure by the government to get the nation's fiscal house in order (i.e. cut the budget deficit) could lead to an inflexible economy that will be prone to hard landings rather than orderly unwindings. This flexibility is key to the economy's ability right now to withstand the onslaught of a big spike in oil and gas prices.
Fair enough. It all sounds good. And there's no doubt that the Federal Reserve as an institution is one of the best-staffed, best-intentioned and brightest in the land. There are many able hands and smart heads to carry on when Mr. G. steps down next year.
But markets may not feel as confident as he does, at least not yet. When there are many targets and rules that are constantly evolving, how will investors know where the Fed is heading? After years of such a strong chairman, how will the group of Fed officials function with an untested leader in the chair?
It remains to be seen. And it will be interesting to see what Greenspan has to say in the months ahead as his day of departure draws closer and it becomes clearer who the next Fed chief will be.
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-- Kathleen Hays is economics correspondent for CNN. For more of her columns click here.
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