Greenspan and rise of the central banker

Dr. Meltzer ranks one achievement as foremost: giving proof "that the economy can have long expansions without inflation." The 10-year period from March 1991 to March 2001 was the US economy's longest recorded period of growth - and far longer than any other peacetime expansion.

Tuesday, for the first time in more than half a century, a Fed chairman will hand over the reins with the "misery index" - the sum of the inflation and unemployment rates - below 10.

A common lament, however, is that Greenspan leaves behind little in the way of a playbook for future Fed chiefs to repeat that performance.

Indeed, if the job is part science and part art, Greenspan embodied the creative side of Fed policymaking. Unlike his successor, economist Ben Bernanke, he does not support the idea of announcing a target rate of inflation. A former jazz saxophonist, Greenspan was known for culling through reports on factory inventories or scrap-steel prices for clues on the economy.

His methods triumphed in the late 1990s, when he detected a hidden surge in productivity. His correct reading of this trend allowed the Fed to let the unemployment rate fall to a level that many said would spark inflationary pressure. Instead the productivity boom acted as a shock absorber against inflation, and joblessness fell to unheard-of lows.

At various times, investors and politicians criticized his interest-rate policies. The elder President Bush, for instance, reportedly blamed Greenspan for not cutting rates aggressively enough in 1991, something that might have improved the economy - and his prospects for reelection. His most controversial moves, however, may have involved words rather than deeds. Greenspan's support for the Bush tax cuts in 2001, for example, raised questions about his independence from the political process. And some argue that his 1996 remark about the possibility of "irrational exuberance" represented too weak a verbal effort to confront a stock market bubble that finally burst in 2000.

Despite these criticisms, most observers acknowledge the steady hand Greenspan kept on the tiller of the American - and by extension, global - economy. "What if the US had not been managed well?" Raghuram Rajan, chief economist at the International Monetary Fund, asks in an interview by e-mail. "I suspect the world economy would have been worse off."

Greenspan's admirers, including Princeton economics professors Alan Blinder and Ricardo Reis, say his record provides a host of lessons for future Fed chiefs.

Among them:

• Avoid policy reversals. When adjusting the Fed's interest rate, Greenspan tended to move in small increments - 0.25 percent at any given meeting.

One benefit of this approach: The Fed is less likely to be forced by events to make a dramatic change in the direction of rates, a reversal that can rattle financial markets and erode the credibility of its decisions.

• Ask "What if we're wrong?" The Fed's policymaking committee, led by Greenspan, tempered its consensus on the "best" policy by factoring in what dangers might arise if that policy proved wrong.

Would the greater risk be in tightening too far or easing too much? In 2003, this risk- management view led the Fed to keep its interest rate low to make sure deflation didn't materialize.

• Keep your options open. While aiming to maintain a consistent and predictable policy, the Greenspan-led Fed allowed a place for discretion as well as rules.

Janet Yellen, president of the Federal Reserve Bank of San Francisco, emphasized this in a recent speech. A systematic approach has been highly successful, she says, yet "it has by no means been a straitjacket for policy during the Greenspan years."

• Look at "core" inflation. With the 1970s oil-price spikes fresh in memory, Greenspan guided policymakers to gauge risks by looking at the core inflation rate, with volatile food and energy shifts stripped out. This view diminishes the risk of driving the economy into recession by tightening interest rates in response to a one-time surge in energy prices.

For the past decade, the core inflation rate has hovered around 2 percent a year. Though prices are rising somewhat, the jump is not so fast that businesses or consumers are lying awake at night wondering about the purchasing power of their dollars.

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