Greenspan shouldn't try to pop bubbles


THE LAWS governing Alan Greenspan and the Federal Reserve say nothing about pricking stock-market bubbles.

The 1978 Humphrey-Hawkins Act orders the Fed "to promote effectively the goals of maximum employment, stable prices and moderate long-term interest rates," not to crack down on the party when the Nasdaq reaches 5,000.

But that's not the excuse Greenspan is using.

In an extraordinary speech last week, he defended the Fed against critics who say the central bank should have tightened the money supply more than it did to keep the stock market from soaring in the late 1990s. By more or less freezing while money poured into dubious technology stocks, these critics charge, Greenspan helped generate the bubble and the post-pop doldrums.

In response, perhaps Greenspan should have stayed silent.

Or perhaps he should have replied: "It's not my job to chaperon loony investors. It's a free country, and if adults with financial resources choose to buy Ariba at $160 a share, that's their business. I'll worry about maintaining the value of the dollar. You decide what to do with it."

But he did neither of those things.

Instead, he defended the Fed's inaction by saying that there was no way of telling at the time that a bubble was forming and that, even if there had been, the Fed might have been powerless to prevent it without wreaking substantial damage.

"As events evolved, 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 Friday at a monetary conference in Jackson Hole, Wyo.

"Moreover, it was far from obvious that bubbles, even if identified early, could be pre-empted short of the central bank inducing a substantial contraction in economic activity, the very outcome we would be seeking to avoid."

In other words, Greenspan seemed to suggest, if the Fed could have seen the bubble coming and deflated it without plunging the country into recession, it would have unsheathed the needle and poked away.

Human motives are always difficult to plumb, doubly so when it comes to deeds of omission. So the Fed failed to attack the bubble. It's history. Does it matter what its stated reasons were?

I think so. Greenspan has expanded the Fed's influence well beyond what the law strictly provides for. More than his predecessors did, he has routinely weighed in publicly and twisted arms privately on tax cuts, budget bills and other matters that the founders assigned to Congress and the executive branch, not the unelected central bank boss.

His speech in Wyoming came off as another presumptuous indicator of the Fed's ambitions. We didn't pop the bubble, he seemed to say, but only because we hadn't learned how. Just give us time.

Indeed, the Fed seems to be working on the problem.

"The endeavors of policy-makers to stabilize our economies require a functioning model of the way our economies work," Greenspan said at the end of his speech. "Increasingly, it appears that this model needs to embody movements in equity premiums and the development of bubbles if it is to explain history."

The unspoken but logical conclusion: Once the econometric models can explain and predict bubbles, "policy-makers" will be able to do something about them.

Yes, you could argue that breaking bubbles is part of the Fed's official job of promoting stable prices and full employment over the long term. But you could make the same case about industrial policy, trade laws and other matters that are none of the Fed's business.

Bubbles are a side-effect of Fed policy, not a statutory focus. By addressing the bubble question without explicitly acknowledging that bubbles do not fall into the Fed's portfolio, Greenspan encourages his successors to do something unwise - such as seeking, finding and busting bubbles that might or might not exist.

He has been a terrific Fed chairman, but he has been lucky to preside when inflation would have been tame and economies ebullient no matter what, so he might overestimate a good central banker's ability to fine tune.

Stick to fighting unemployment and inflation, Mr. Greenspan, and don't even speculate about a more grandiose role. Remember that the Fed, too, is a government agency. Your job is to provide a cushion for the markets, not a ceiling.

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