Greenspan finds excuses to cool asset prices

The Sunday Times London

November 7, 1999

It isn't easy being the world's most famous and respected economist and central banker. Consider the problems confronting Federal Reserve Board Chairman Alan Greenspan as he decides whether or not to raise interest rates next week, as have the Australian and British monetary authorities, and the European Central bank.

Recently released data suggest that personal incomes have stopped rising. But a closer look reveals that government data-gatherers deduct from income uninsured losses from storms. So the recent stagnation in incomes probably -- but not certainly -- reflects the effect of the damage inflicted by hurricane Floyd, rather than any fundamental reversal of the modest upward trend of incomes.

New data also might lead the unwary to believe that the savings rate in America has suddenly turned up. But look again: the numbers crunchers have decided for the first time to include in savings the massive sums that federal employees salt away in their pension plans.

Then there is the key housing market. "Rate rises cool US housing market", the Financial Times informs us -- a day before the Wall Street Journal reports the same figures under the headline, "U.S. New-Home Prices Soar to a Record." Both papers are right, of course. Sales of new homes in September were at their lowest level in almost two years, but prices rose

2.3% to a record average of $196,900. Cooling down, or heating up?

The performance of property prices is now attracting more attention from central bankers than ever before. For some time, bankers charged with setting interest rates looked only at the prices of goods and services bought on a regular basis by consumers. Then, when share prices headed skyward, policy makers began to think they should pay more attention to the so-called "wealth effect" -- the impact of increased wealth on consumer spending. After all,

when consumers feel richer -- indeed, are richer -- they are likely to spend more and save less.

Lately, policy makers have turned their attention to property prices, which are on the rise in both the US and the UK. In America, Greenspan used the occasion of a speech to bankers to point out that "a significant amount" of the capital gain realized by sellers of houses "is spent on consumer goods, especially big ticket items...". Indeed, the Fed reckons that whereas consumers will spend 3-to-4% of any increase in the value of their shares, they will spend more -- some 5% -- of the wealth they acquire when the value of their houses goes up.

So should central bankers take it as part of their inflation-fighting job to rein in rising share and property prices, and to act as bubble-busters? The economists at Bank of America Securities think not. Mickey Levy, chief economist concedes that the wealth effect "is adding to economic growth", but argues that the stock market is up "largely due to excellent economic and inflation fundamentals", so that rising share prices are more an effect than a cause of rising economic activity.

John Vickers, executive director and chief economist of the Bank of England agrees. In a lecture at Oxford University, Vickers laid out with his usual clarity and good sense the relation between monetary policy and asset prices. The prices of assets are relevant because "asset prices on their own can yield information for monetary policy purposes" that is quite valuable. And homes, and the loans secured to buy them, are the most important assets and liabilities of the personal sector -- a fact of economic life in the US, the UK and many other countries.

But, argues Vickers, it is difficult to determine the effect of rising house prices on the economy. People feel good and buy more consumer durables. But non-homeowners may reduce their purchases of non-housing services in order to finance a house purchase. Best, then, to look at house prices as one of many pieces of information about the state of the economy, but not as "an independent concern of monetary policy".

So, too, with share prices. Central bankers have no way of knowing whether a "bubble" exists, or whether rising share prices merely reflect economic fundamentals such as profit growth rates. Moreover, even if they think they are wise enough to discern a bubble, the bankers do not know how to burst it.

So monetary policy makers had best confine themselves to using asset prices to "help inform judgments about inflation prospects", concludes Vickers. Bubble busting is not their line of work.

The question is whether Greenspan, whose talks on the subject have been a model of obfuscation, says he agrees that central bankers should not try to outguess the markets as to the "right" level of share prices. But ever since his "irrational exuberance" speech, made when the shares were one-third cheaper than they now are, Greenspan has been inclined to drop hints that he is uneasy about the level of share prices, and that their height is one factor that might force him to raise interest rates.

Now that he is less worried about the possibility of an Asian financial meltdown, and can go back to being America's central banker rather than the world's, Greenspan can try his hand at cooling asset prices just a bit. And he can do so without admitting to targeting share or property prices. For recent reports from around America are revealing mounting labour shortages and increasing wage pressures. New York employers say they have run out of temps to hire, trucking companies have vehicles sitting idle for lack of drivers, and production-line workers are complaining about being forced to work excessive overtime.

Throw in a trade deficit that promises a weaker dollar and more expensive imports, and you have enough reasons to raise rates without even mentioning asset prices. Which should spare Greenspan the necessity of confessing to bubble-bursting proclivities.