End of an Era

Tuesday's World Events — Posted on January 31, 2006

(by Timothy Lamer, WorldMag.com) – The Labor Department reported on Jan. 18 that the consumer price index rose by 3.4 percent during 2005.

The fact that most people probably missed that news–or they heard it and promptly forgot it–is a testimony to Alan Greenspan’s tenure as chairman of the Federal Reserve Board. Thirty years ago, everybody would have heard about a CPI gain of 3.4 percent, and nobody would have forgotten it. Politicians, rushing to podiums to claim credit, wouldn’t have let them forget.

High inflation was the norm back then, and it’s worth keeping in mind how different things are today as Mr. Greenspan ends his 18-year chairmanship of the U.S. central bank on Jan. 31.

Those who do remember know the 1970s were a time of politicized central bankers who boosted money supply as a short-term stimulus ahead of elections–only to ignite inflation later. The United States suffered through double-digit inflation for three years in a row, from 1979 to 1981, and it took an unpopular tightening of money by then-Fed chairman Paul Volcker to stabilize things.

Mr. Greenspan’s great accomplishment is that he preserved and extended Mr. Volcker’s hard-won victory. Annual inflation topped 5 percent only once during Mr. Greenspan’s watch (in 1990), and it stayed at 3 percent or below 11 times.

Good things happen when inflation is low, and Mr. Greenspan’s tenure has witnessed a strong run for the U.S. economy. Productivity has soared, and the economy has grown steadily with only two mild recessions. Even more impressive: These gains happened despite a stock market crash (in 1987), a collapse in Asian currencies, and a terrorist attack on the nation’s financial center.

It’s a good enough record to forgive what might be a hint of irrational exuberance in Princeton University economists Alan Blinder and Ricardo Reis, who wrote about Mr. Greenspan last year: “We think he has a legitimate claim to being the greatest central banker who ever lived.”

Still, Mr. Greenspan is not without opponents who say he’s been too easy with monetary policy. In response to the bursting of the tech bubble (which some say Fed policies helped to create), Mr. Greenspan began an aggressive round of interest rate cuts in 2001 that some analysts blame for today’s housing bubble and the dangerously high levels of debt that Americans keep piling up. (U.S. households now spend almost 14 percent of their after-tax income on servicing debt.)

“The jury is out on his legacy in large part because of the debt” problem, Stephen S. Roach, chief economist at Morgan Stanley, told The Washington Post. “You will not be able to truly judge his accomplishments until we see how this plays out in the post-Greenspan era.”

It’s now up to Ben Bernanke, the new Fed chairman, to keep the dollar’s value stable and the economy humming. His job will be much tougher than Mr. Greenspan’s was. He likely will be in office when the first wave of baby boomers begins to retire–an unprecedented challenge to the U.S. economy and one that politicians refuse to face.

And then there are those troubles with housing and debt, which economist Mark Zandi told CNN are on the horizon: “I would attach a reasonably high probability that there will be a problem in the housing or finance markets that will test the next Fed chairman.”

Questions

1. Write the letter of the definition in the blank next to the term that it describes

_____ consumer price index

_____ Federal Reserve Board

_____ inflation

_____ monetary policy

_____ interest rate

_____ housing bubble

_____ econonmist

_____ baby boomers

a - An increase in the general price level of goods and services; alternatively, a decrease in the purchasing power of the dollar.

b - an expert in the science of economics

c - Measures the change in the cost of living for most American families. Widely followed as an indicator of inflation of retail purchases.

d - The cost of borrowing money, expressed as a percentage, usually over a period of one year; The percentage of an amount of money which is paid for its use for a specified time

e - someone born in a period of increased birth rates, such as those following World War II. In the U.S., demographers have put the generation's birth years at 1946 to 1964

f - a tool by which government can influence the economy by affecting interest rates. In the case of the US, the Federal Reserve Board may choose to increase interest rates thereby slowing the economy and dampening inflation, or decrease interest rates which may stimulate the economy by stimulating investment and consumption

g - a type of economic bubble that occurs periodically in local or global real estate markets. It is characterized by rapid increases in the valuations of real property such as housing until they reach unsustainable levels relative to incomes and other economic indicators, followed by rapid decreases that can result in many owners holding negative equity (a mortgage debt higher than the value of the property).

h - a government appointed organization which runs the central banks in the USA; A group of economists and other experts who set the nation's monetary policy. The board's most powerful tool to control inflation is the power to control interest rates.

2. Name the current and the past two chairmen of the Federal Reserve Board.

3. How much of an increase was there in the CPI in 2005? How do you know from para.#2 that that number was a good thing?

4. In what years did the U.S. have double digit inflation? Ask your parents or other adults to describe how that double-digit inflation affected them (their experience with jobs, ability to save money, living expenses at that time, etc.)

5. What happens when inflation is low? What was impressive about the low inflation during Mr. Greenspan's tenure?

6. What do critics of Mr. Greenspan say is a result of what they think was his "too easy monetary policy"?