Posted on: Saturday, August 31, 2002

Fed chief defends handling of '90s economic 'bubble'

By Martin Crutsinger
Associated Press

WASHINGTON — Alan Greenspan, explaining one of the few economic stumbles during his long tenure at the Federal Reserve, said yesterday that if the Fed had tried to burst the speculative stock market bubble of the late 1990s, it could have dumped the economy into a severe recession.

The man who once famously wondered whether investors were in the grip of "irrational exuberance" defended his handling of Wall Street's long bull market during an address to a Fed-sponsored economic conference.

"The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble is almost surely an illusion," the Fed chairman told participants at the economic symposium in Jackson Hole, Wyo.

Some critics have argued that the central bank made a major policy error by failing to curb stock prices as they soared into the strastosphere, setting the stage for a specta-

cular market crash beginning in the spring of 2000 that has seen more than $7 trillion in investor wealth wiped out.

For the Fed to have significantly influenced the level of stock prices during the market boom would have required such a big hike in interest rates that it would have run the risk of pushing the economy into a recession, Greenspan argued.

To support this view, he noted that during the long bull market that began in the early 1980s, the Fed did raise interest rates by more than 3 percentage points on two occasions and this only had a brief depressing effect on stock prices.

"Such data suggest that nothing short of a sharp increase in short-term rates that engenders a significant economic retrenchment is sufficient to check a nascent bubble," Greenspan said.

In his remarks yesterday, Greenspan said Fed officials realized during their internal debates that it was hard to determine when a stock bubble was developing.

"We recognized that despite our suspicions, it was very difficult to definitively identify a bubble until after the fact — that is, when its bursting confirmed its existence," Greenspan said.

While the Fed did raise interest rates by a single quarter-point in March 1997, the Asian currency crisis that began unfolding in the summer of 1997 put any further Fed rate increases on hold and the Fed's next move in the fall of 1998 was to cut rates rapidly to keep the global turmoil from derailing the U.S. economy.

Analysts said Greenspan was right to worry about protecting the U.S. economy even if the extra money he supplied to the financial system contributed to further speculation in stocks.

"With all the knowledge we have today, the Fed probably did overdo the credit-easing in 1998, but if the Fed had been raising interest rates to deal with the stock market bubble, it could have pushed the U.S. and the global economy into a deep recession that would have been far worse," said Sung Won Sohn, chief economist at Wells Fargo in Minneapolis.

Since peaking in spring of 2000, the Dow is down 24 percent and the Nasdaq index lost 74 percent. There are worries that this summer's renewed stock decline could derail the economic recovery.