Greenspan Keeps Us guessing On Interest Rate Rise

The Sunday Times (London)

20 June 1999

The game of will he, won't he, continues to fascinate Greenspan watchers from Wall Street to the City. So they have studied every word of the Fed chairman's testimony before congress last week, looking for a clue as to whether he will raise interest rates at month's end.

But this is a silly game, for two reasons. First, even the most skilled player cannot penetrate the fog that surrounds every sentence spoken by chairman Greenspan -- unless he chooses to send a clear message, in which case the game is anyhow over. Greenspan says that productivity is improving, keeping unit labour costs down, say those who are betting he won't raise interest rates. Ah, but he says further improvements will be harder to come by, and that the pool of available workers has been drained dry. So look for him to make a preemptive strike against inflation by raising rates, say players on the other side of the gameboard.

No one can win this game -- which brings us to the second reason why it is a silly exercise. The markets have already decided that all of the figures showing that inflation is dead are missing something that is going on in the American and world economies. Three somethings, actually. The first is the condition of the labour market. The low unemployment rate is one part of the story of this market. The record-high participation rate -- the portion of the total population that is in work -- is another. And anecdotal evidence is still another.

On the high end of the labour market are the Silicon Valley companies that depend on producers of what has come to be called intellectual property -- the computer programmes, web sites and other stuff of the computer-Internet age. These firms have imported so many workers from abroad in the first five months of the year that they have exhausted the entire annual immigration quota established by the Clinton administration at the behest of the trade unions.

On the low end -- well, lower end -- of the market is the federal government, which plans to hire 860,000 workers to conduct next year's national census. That's how many it will take to count every American, a process that determines how many congressional representatives a state gets, and how federal welfare money is distributed. Labour markets are so tight that the Census Bureau plans to rely on students, retirees, and other part-timers to get the work done. And to pay between $7 and $18 per hour, depending on local labour market conditions, up from the $5.50-to-$9 it paid enumerators in 1990.

In addition to the tight labour market, market-watchers are coming to believe that the world economy might, just might, be coming right. The crisis in Asia seems to have bottomed out, with Japanese high-end retailers welcoming back customers who have stayed away for more months than the shopkeepers care to remember. Brazil seems to have righted itself, with foreign capital starting to return, to the tune of $10 billion last month alone. Even the German economy seems to have moved from comatose to merely moribund, with a collapsing euro spurring exports. All of this may give the world's demand for commodities a fillip, and put a bit of upward pressure on commodity prices.

Finally, there is the American consumer. Retail sales are up nearly 8% over last year's level, autos are moving off the lots at a record pace, and consumer confidence rose in May for the seventh consecutive month -- a record string of increases. Analysts keep hunting for signs that consumers will slow the pace of their spending, but can't seem to find any.So long as the consumer keeps spending, the labour market will stay tight; and sooner or later that tightness will be reflected in higher unit labour costs, talk of a "new paradigm" notwithstanding, or, as Greenspan put it in last week's testimony, "absent the unlikely repeal of the law of supply and demand."

All of these signs led investors to drive bond prices lower, and interest rates to only a bit below 6% on the Treasury long bond -- without any nudging from the Fed. And induced Greenspan, who feigns insult if accused of uttering an unambiguous sentence, to give what by his standards is a clear warning that he is worried about the sustainability of the 4 percent growth rate that characterises the US economy. Monetary policy, he said, should "preempt forces of imbalance ... because modest preemptive actions can obviate the need of more drastic actions at a later date."

Which tempts me into the silly game of will he or won't he game. Models based on history are useless, as they consistently under-predict productivity growth and over-predict inflation. So a policy-maker is reduced to informed intuition and guessing which is the worst error: raising rates and wishing he hadn't, or not raising them and wishing he had.

In this case, raising interest rates now, even if subsequent data show the increase was unnecessary, risks slowing the economy a bit, and taking a bit of air out of share prices. Not a very costly error in an economy growing at a 4 percent annual rate.

Failing to raise rates, on the other hand, risks unleashing inflationary pressures that will prove difficult to contain. Worse still, the closer we get to the presidential elections of 2000, the more difficult will it be for the politically astute Fed chairman -- up for reappointment by the president in June of 2000 -- to raise rates. So it is now or wait until 2001.

So if I must play the game, I enlist on the side of "he will" -- and by more than the quarter of percentage that the market is expecting. Unless, of course, he doesn't .