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Thursday, September 27, 2007

Greenspan's "Pending Tsunami"

If you haven't had your fill of Greenspan lately, here's one more. Bloomberg's John Berry says Greenspan's forecast for the next quarter century is not very persuasive:

Greenspan Says 'Pending Tsunami' May Hurt Fed, by John M. Berry, Bloomberg: In the final chapter of his book, ''The Age of Turbulence,'' Alan Greenspan lays out what he sees for the next quarter-century: falling world saving, rising inflation, higher interest rates and extreme political pressure on the Fed to let 'er rip.

His scenario isn't impossible. However, he doesn't really build a convincing case for it. ...[He] writes. ''...I fear that containing inflation through higher interest rates will be as unpopular in the future as it was when Paul Volcker did it more than 25 years ago.''

Some of the reasons cited by Greenspan for his concern -- such as the potential for greatly increased federal government spending as the Baby Boom generation retires -- are certainly valid. Another, however, isn't.

Greenspan says he believes that increased globalization has been a significant force holding down inflation and that that force is waning, which will make life more difficult for the Fed. ...

However, in a June 2006 speech at a Boston Federal Reserve Bank conference, Fed Vice Chairman Donald L. Kohn challenged the proposition that globalization has had a significant impact on U.S. inflation.

Kohn acknowledged that the pace of globalization had accelerated. Nevertheless, the impact of that on inflation, he said, ''is less obvious.'' For one thing, changes in exchange rates may absorb effects of inflation that might be transmitted from one country to another, he said.

''Many U.S. goods and most services are still produced domestically with little competition from abroad,'' Kohn said. ''In addition, the significant expansion of production in China and elsewhere has put substantial upward pressure on the prices of oil and other commodities, many of which are imported for use as inputs to production in the United States.

''Indeed, the effects of globalization on domestic inflation need not even be negative, especially in today's environment of strong global growth,'' he said.

Greenspan doesn't exactly predict what inflation will be between now and 2030. ... Americans won't get angry enough to force politicians to let the Fed rein in inflation until it gets above about 5 percent, he says. Without a change in current policies regarding federal benefits for retirees, this ''pending tsunami'' may heighten inflation pressures to the point that the Fed would have to resort to double-digit interest rates to keep prices constrained.

Would the public and the politicians stand for interest rates again being as high as they were in the early 1980s? Greenspan doubts it, citing past efforts by some members of Congress to limit the central bank's independence.

The reality of that period, though, was that while there was a great deal of posturing by politicians, there was never a serious effort on Capitol Hill to interfere with Fed policy. ...

Furthermore, at that point some economists -- and many politicians -- believed there was a trade-off between inflation and unemployment. That is, that you could create more jobs by accepting somewhat higher inflation. Economists now are sure that trade-off can work only in the short-term...

And during the heady second half of the '90s, politicians saw convincingly that very low unemployment and very low inflation could co-exist. ...

As for the next 25 years, keep in mind that as painful as Fed policies were a quarter-century ago, Volcker and his colleagues ultimately were successful.

    Posted by on Thursday, September 27, 2007 at 12:33 AM Permalink  TrackBack (0)  Comments (5)

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