It is difficult to figure out what this article is saying,
but these excepts may provide a clue:
What lifts asset prices, Mr. Bernanke and others argue, is
the willingness of lenders to offer riskier types of
loans, which "juice up the housing market and are not very
responsive to interest rates," as Mark Zandi, chief
economist at the research firm Economy.com , put it.
"There are two ways to approach bubbles: one is interest
rate policy, the other is microregulatory policy," he
said... Pursuing his point, he added: "Research on
historical episodes suggests that large asset price
increases are sometimes preceded by credit booms. In many
cases, this pattern results from the fact that the country
in question deregulated its banking system, giving banks
extra powers, but did not enhance the supervisory
structure adequately at the same time."
It seems the idea is to increase bank regulations,
reducing the number of risky loans. This makes sense in
many ways, but it will probably mean that investors will
move their money to less restrictive opportunities
elsewhere.
rkm
--------------------------------------------------------
http://www.nytimes.com/2005/11/04/business/04fed.html
November 4, 2005
The Greenspan Effect
To Fight Rising Prices, Fed Nominee May Need New Weapons
By LOUIS UCHITELLE
Early in his tenure as chairman of the Federal Reserve,
Alan Greenspan declared that the risk of too much
inflation was so considerable that he would "err more on
the side of restrictiveness than of stimulus."
And he meant it. At his very first meeting, in August
1987, Mr. Greenspan established his inflation-fighting
credentials by pushing up short-term interest rates in
response to only a modest rise in consumer prices, a move
that contributed to the stock market crash just two months
later.
Ben S. Bernanke , who is expected to take over at the Fed
in February, will almost certainly echo Mr. Greenspan's
step, raising rates at his first meeting next year, in
part to demonstrate his commitment, too, to keeping
inflation under control. But for all the similarities of
their actions upon taking office, Mr. Bernanke faces a
fundamentally different set of circumstances than those
that Mr. Greenspan confronted 18 years ago.
"Inflation is clearly not right around the corner like it
used to be," said Edward M. Gramlich, until recently a Fed
governor and now interim provost at the University of
Michigan. "The relationships are different, and Mr.
Bernanke is going to have to figure them out."
Perhaps the biggest differences are the rise of global
production, as well as much easier access to capital,
particularly from abroad. Adding to the change is labor's
weaker bargaining power. These factors have combined to
greatly diminish the force of old-style inflation in which
demand outran supply, pushing prices ever higher, and
wages, too, until the Fed put the brakes on the economy.
Instead, a new style of inflation has emerged as one of
the principal threats to the economy. It is evident in the
stock market bubble of the late 1990's and in surging home
prices in this decade. This asset price spiral, as it is
called, has proved much more resistant to the Fed's
standard interest rate tool than traditional inflation.
Mr. Bernanke, for his part, is known as an advocate of
inflation targeting, a technique for adjusting interest
rates with the aim of keeping traditional inflationary
pressures within a limited range. He has also asserted,
like Mr. Greenspan, that he does not intend to use
interest rates prematurely to puncture an asset bubble.
But he has signaled a readiness to use a different set of
tools to fight the new inflation, and in this he departs
from Mr. Greenspan.
What lifts asset prices, Mr. Bernanke and others argue, is
the willingness of lenders to offer riskier types of
loans, which "juice up the housing market and are not very
responsive to interest rates," as Mark Zandi, chief
economist at the research firm Economy.com , put it.
Lenders can engage in riskier loans because they have
developed techniques in recent years that make it far
easier for them to shed their vulnerability to risk, doing
so mainly by shifting the risk of default to others. The
lenders operate in sophisticated markets that allow
thousands of individual investors to purchase a slice of
the original loan, and a slice of the risk.
In the past, the danger of default as rates rose tended to
discourage lenders from making overly risky loans. The
lender, often a bank, kept the loan and bore all the risk.
Mr. Bernanke, in response to the risk shifting, has raised
the possibility of limiting the dangers through the use of
regulations - microregulatory policy, he calls it.
"There are two ways to approach bubbles: one is interest
rate policy, the other is microregulatory policy," he said
in a little noted interview published last year by the
Federal Reserve Bank of Minneapolis. "Microregulatory
policy is the much better approach, in my view," Mr.
Bernanke said.
Pursuing his point, he added: "Research on historical
episodes suggests that large asset price increases are
sometimes preceded by credit booms. In many cases, this
pattern results from the fact that the country in question
deregulated its banking system, giving banks extra powers,
but did not enhance the supervisory structure adequately
at the same time."
The surge in oil and gas prices is another big source of
inflation that Mr. Greenspan did not have to deal with in
his early days as chairman, and through most of his
tenure. Many economists argue that rising interest rates
are a double-edged sword under such circumstances.
They note that higher fuel prices do not blunt the demand
for petroleum products. Rather than cut back on purchases
of gasoline and heating oil, consumers offset the rising
cost by cutting back first on other purchases: automobiles
and appliances, for example. That slows the economy.
Rising interest rates encourage this cutback, slowing the
economy even more.
"Whereas in 1987, it was clear that the way to combat
inflation was to raise interest rates," said Brian Sack, a
senior economist at Macroeconomic Advisers who once wrote
a research paper with Mr. Bernanke, "today the Fed's
policy makers have to be cognizant that the higher energy
prices are slowing the economy" on their own.
Not that Mr. Bernanke would be less diligent than Mr.
Greenspan in resorting to interest rates to prevent
inflationary expectations from creeping back into consumer
and business behavior. That happens when prices rise
unchecked, as they did during the oil shocks of the
1970's, encouraging people to buy more to avoid paying
higher prices later.
The stepped-up demand only encourages more price
increases, and then wage increases to keep up with the
price increases, until the Fed, in response, pushes
interest rates so high that the economy is knocked flat on
its back and demand finally is punctured.
Paul A. Volcker took this route as Fed chairman in the
1980's; so did his successor, Mr. Greenspan, who pushed up
rates to nearly 10 percent in his first three years,
helping to provoke the early 90's recession, which further
reduced the inflation rate.
Mr. Bernanke has no intention of reversing these gains.
"Inflation-averse central bankers," he said in a speech
last fall, while he was serving as a Fed governor, before
shifting to chairman of the White House Council of
Economic Advisers, are "likely to contribute to increased
central bank credibility and hence better policy
outcomes."
But his world is different from Mr. Volcker's and Mr.
Greenspan's. They dealt with a more closed, less global
economy. If the nation's manufacturers were running their
factories flat out, using all their productive capacity,
and were still unable to meet demand, the shortages were
considered inflationary.
That made capacity utilization a much-discussed concept in
Mr. Greenspan's early days. It is now rarely mentioned,
for good reason. The output - the capacity - of other
countries pours into the United States. In 1987, factories
in this country supplied nearly 95 percent of what
Americans consumed; today they furnish less than 80
percent.
Another pillar of old-time inflation was wage pressure
that intensified as unemployment fell. Not long after Mr.
Greenspan became chairman, the jobless rate dropped below
6 percent and kept falling, a traditional signal that a
shortage of workers would give them leverage to negotiate
higher wages.
Economists argued endlessly about how low the unemployment
rate could go before inflation began to accelerate, pushed
along by rising wages. They referred to this balancing act
as the nonaccelerating inflation rate of unemployment,
another economic concept seldom mentioned today.
The trade-off reflected labor shortages that have since
diminished as additional production of goods and services
has shifted abroad, in effect globalizing the nation's
labor supply. The unemployment rate has held below 5.5
percent since February, but instead of rising, median
wages - adjusted for inflation - have fallen.
The Fed's policy makers also responded much more in the
late 80's to what they perceived as a potential shortage
of capital. The concern was that American investors could
not easily finance the Reagan administration's rising
budget deficit and also the credit needs of the private
sector.
The competition for the limited supply of funds came to be
known as "crowding out," another concept now discarded as
foreigners, particularly the Chinese, pour their savings
into Treasury securities. In 1987, 15 percent of all
Treasuries were owned by foreigners; today 45 percent are.
"It may have been the case," Mr. Gramlich said, "that when
the Fed tightened, the higher rates would crowd out some
investment. Now you don't have that effect. Rates rise and
you suck in more capital."
To be sure, the gradual shift to a more global economy and
the vast expansion of global capital markets have not left
the central bank with no inflation to fight. But the
dynamics have changed.
"Sometimes people ignore the rest of the world and think
of the United States as an isolated island," said Alan S.
Blinder, an economist at Princeton University and a Fed
governor in the Greenspan era. "That is clearly incorrect.
"Or you can view the United States as a big cork bobbing
in a figurative sea that is the global economy," Mr.
Blinder added. "That is also incorrect."
Copyright 2005 The New York Times Company
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