Demystifying Mr. Greenspan

It was November 1, a Tuesday, and Kenneth N. Gilpin, a reporter in The New York Times business section, had a tough assignment for the next day's paper. He had to explain why both stock prices and bond prices had dropped dramatically in the face of good news about the economy.

That seemingly weird reaction had been occurring pretty much all year, of course, as the Federal Reserve System raised interest rates, again and again, in an effort to keep the economy from growing so fast it would ignite inflation. And it had been explained, again and again, by reporters who covered the financial markets. Usually, they said that given the Fed's determination to cool things off, investors felt that any new statistic indicating that the expansion was still going strong probably meant yet another Federal Reserve move toward higher rates, slowing growth and hurting at least the short-term value of their holdings. And that is just what Gilpin said in his lead.

But he had an extra problem to deal with that day; just the previous Friday, the stock and bond markets had done the exact opposite. They'd gone up in the wake of a batch of favorable economic statistics. And analysts had taken that as a sign the markets were suddenly no longer afraid of good news.

Gilpin grasped the nettle firmly.

 "The reverse in course yesterday," he wrote, "seems to reflect how nervous investors are about inflation and how unsure they are about the economic outlook. That uncertainty makes it easy for the market to shift its course sharply from day to day as it digests new economic data."

 There was only one thing wrong with that. Like virtually all coverage of the financial markets, it was based on the unstated assumption that whatever happens in those markets always has a rational basis.

Gilpin does not deserve to be singled out for criticism about this. He handled his assignment better than many had done, on the Times or elsewhere, through the year. He had resisted the standard temptation to reach out for any development he could find, obscure or otherwise, that would "explain" exactly why stock and bond prices had done the unexpected again.

But the persistent assumption that the decisions of all the professionals and amateurs who buy or sell securities, on any given day, always add up to a result that is somehow "right" is nonsense. And the unremitting coverage based on that notion, considering how completely market news dominates overall economic news with its sheer daily volume and the play it gets, gave the public little help in deciphering the economic events of 1994 and the Fed's role in them.

It does need to be noted, immediately, that the reporters who spend full time covering national economic policy, most of whom work in Washington, are generally very good. They really understand economics, work hard at it, and write it so the public can understand, too.

Still, rereading hundreds of their stories, including newsmagazine pieces and TV scripts, written over the past year, it is impossible not to be struck by how often their coverage of Federal Reserve policy looked to financial market analysis for validation of the Fed's actions. And how often they omitted other important information that might have shed quite a different light on them.

 That is not to say that Federal Reserve policy was wrong; the returns are not in, and the evidence that the Fed may be right keeps getting stronger. The point is that the coverage, especially the stories aimed at the general reader, detailed the factors and opinions that buttressed the Fed's reasoning much more often and more completely than it did those that weakened it. In fact, except at the start of the Fed's series of rate increases in February and March, the A-section stories seldom dealt in more than a cursory way with the basic questions that were being raised by the Federal Reserve's actions.

There were at least four such questions. Did it make sense for Chairman Alan Greenspan and the other Fed policy makers to see a threat of inflation when more than eight million people remained out of work? Can there really be a danger of inflation when the Consumer Price Index and the other major statistics on prices are consistently showing the smallest increases in years? Is the Fed right in arguing that its actions will benefit even the unemployed because higher interest rates will keep the economy expanding more slowly, but for a longer period of time, during which unemployment will continue to drop? And while it's widely accepted that the Fed has to act before there are conclusive signs of inflation (because the effects of rate increases are not immediate) is it also true that it must act early because inflation, once started, necessarily gets worse and worse, and is much harder to reverse than any recession that could result from its actions?

 Greenspan and most of his colleagues among the Fed's leaders have answered with a ringing affirmative to every one of these questions. And they have cited the interest-rate increases in the bond market, which were outdoing anything the Fed was directly causing, as confirmation that they were right to see inflation just over the horizon.

There were, in fact, reasons other than a fear of inflation, or even a reaction to the Fed's actions, for the behavior of the financial markets.

On May 20, The Wall Street Journal published one of its famous, long, page one "leaders," by Washington-based David Wessel and New York-based Laura Jereski and Randall Smith, which explained in compelling detail that an awful lot of the recent plunge in bond prices had nothing to do with fears of inflation. Rather, the reason was that the Fed's actions raising rates had caught a large number of speculators with huge sums of money invested in complicated ways that amounted to bets that interest rates would remain low. Therefore, they'd been dumping these investments as fast as they could, now that the Fed was raising rates, and that was what was pushing bond prices down and interest rates up.

But this important insight, based on some impressive reporting, essentially disappeared from the Journal after that one story, even though everyone in the financial markets knew that speculative positions of this kind had not disappeared from the markets with that one shakeout.

 This now-you-read-it-now-you-don't history of one particular Journal story is just a single example of the sort of thing that kept happening all year: good reporters kept forgetting to point out to their readers important things they knew perfectly well themselves, things that had a real bearing on the issue of whether the Fed's policy was the right one.

On October 26, for another example among many that might be chosen, The Washington Post's business section carried a piece by John M. Berry on the exceedingly small increases in employee wages and benefits through the first nine months of the year, as detailed in a new report from the Labor Department. Although the same story noted, correctly, that the Federal Reserve was expected to approve yet another rate increase the next time its policy committee met, Berry's lead said forthrightly that the new figures "suggested that the fear [of inflation] may be exaggerated." But it was the only time he highlighted this highly significant information. And not in the A-section pages that are seen by the general readers.

Somebody has called this the "I already wrote that" syndrome. It is a common ailment among journalists on every beat -- as if writing something once has fixed it forever in the minds of the readers and viewers.

Much other important economic information was carried, throughout the year, only on business pages or broadcasts tailored for a business audience, and virtually never saw even an inside page in anybody's A-section. That was a fate also shared by the knowledgeable and readable copy filed by Martin Crutsinger of the AP Washington bureau and several of his colleagues.

Among the significant matters thus essentially hidden from average readers were developments that indicated that the American economy of today is part of a changed world. Numerous new factors are operating to constrain inflation, whereas the Fed seemed, to many, to be acting on outdated facts and assumptions.

 One of the new phenomena is the huge expansion of international trade and competition. The increasing availability of imports, quite simply, limits the ability of many American producers to charge higher prices.

Another is the widely publicized mass layoffs of recent years, which have made both union and nonunion workers more hesitant about asking for increased wages and benefits. Even in manufacturing, employee compensation is the major cost of production, but in an economy increasingly dominated by services, labor costs amount to about two-thirds of the expenses of producing everything businesses make and do in this country. As John Berry's piece indicated, if labor costs aren't rising much, there's little or no source of inflationary pressure from that side of the economy.

The recent solid increases in U.S. productivity, defined as what one worker can produce in one hour, hold costs and prices down, too. Productivity has long been described as the magic that permits wages to go up while prices remain stable. Since it's been rising faster than wages lately, that leaves room for somewhat larger wage increases without any inflationary consequences.

Improved worker productivity results, in part, from all those layoffs but also from the huge investments businesses have been making in new and more efficient facilities and equipment. And that's still going on, with effects on productivity yet to be fully realized. This surge in business spending on new plants and machinery does get covered in stories on the growth of the Gross Domestic Product, to which it contributes quite a bit, and these do often make the network news or start on page one. But its role in controlling inflation does not appear in stories discussing the wisdom or unwisdom of Federal Reserve policy. Certainly not those that ran in the main news sections of the newspapers, or on general-interest broadcast news programs.

 Furthermore, all this shiny new plant and equipment, which will require less down-time for maintenance, should enable businesses to operate all out -- closer to 100 percent of theoretical capacity than in the past -- without threatening inflation. That is a point that has barely been made, even on the business pages, even though today's historically high rate of what's known as "capacity utilization" has been given as one of the big reasons why the Fed is so worried about inflation.

 All these matters add up to a considerable body of evidence that the policy-makers at the Federal Reserve are relying on history, and maybe history is no longer a reliable guide.

Nor did the strong challenges to the Fed's rationale and actions from Democratic members of Congress get much play. The lively anti-Fed rhetoric of Sen. Paul Sarbanes of Maryland, for one, was sometimes quoted, but the detailed statistics he provided to back up his criticisms were not. What was worse, any story that quoted any part of what he said almost always noted that he was up for reelection, as if that somehow rendered his substantive arguments wholly invalid.

 The unwillingness of President Clinton and his top economic policy team to make any public case against interest rate increases, after about March or April, also contributed greatly to the imbalance in coverage. If the president or Treasury Secretary Lloyd Bentsen or top economic advisers like Laura D'Andrea Tyson had been challenging the Fed, they would surely have been quoted at length. But they hadn't been, quite likely because they feared that such arguments might be heard in the financial markets as a statement that the administration just didn't give a rap about inflation, an inference that might literally have panicked the financial markets.

Another explanation for the silence of Clinton and his people may be that they had come to believe the Fed might be right, though they plainly did not in the beginning. That is a thesis for which there is some evidence in the views of such individuals as Alan S. Blinder, now Clinton's appointee as vice chairman of the Federal Reserve Board, but until recently a member of the President's Council of Economic Advisers. He comes pretty close to accepting the Fed's arithmetic about the levels of economic growth and unemployment where the danger of inflation sets in.

 Whatever the reasons for the hush that came over the administration, journalists apparently felt absolved from looking elsewhere for responsible critics of the interest rate increases.

 On the Fed's side of the argument, some important aspects went undercovered, too, or ran only in the business sections or on those few broadcasts specifically aimed at a business audience.

 One centers on what may be yet another basic change in the workings of the economy: the development of the phenomenon sometimes called the "dual" labor force. People with good educations and training and significant experience have quite low rates of unemployment, despite all the widely publicized layoffs of middle managers. The labor force may soon start running short of such people, the Fed and others think, and that could put some real upward pressure on wages. This, too, has mostly been discussed only on the business pages or on TV and radio programs aimed at a business audience.

Another development on the pro-Fed side is what has happened to "producer prices." Even on the business pages, the headlines and stories have focused mostly on the figure that summarizes the overall picture -- the prices of everything from the iron ore to the new car as it leaves the factory -- and that hardly went up at all. But there was a substantial run-up in prices of what are called "intermediate" goods, the stage in between raw materials and finished products. While many makers of finished products report that they are finding resistance to increased prices on what they are selling, they also say they can't go on indefinitely paying more to their suppliers without charging their customers more.

Also largely missing from the coverage, as the year wore on, was the widely accepted view, even among economists who are Democrats and liberals, that the "Federal Funds" interest rate -- the basic rate the Fed kept raising -- was unsustainably low when the Fed began its series of rate increases in February. It had been pushed down to 3 percent in 1992 during the early stages of recovery from the 1990-91 recession, specifically to stimulate additional economic activity.

 Not until the May 1994 rate increase, the fourth of the year, did Fed officials feel they had reached the point where they had stopped stimulating growth and reached a neutral stance. By that time, there were many who argued that they'd gone far past that stage into clamping down on growth. Among them were the president of the National Association of Manufacturers, himself an economist, and the chief economist of the Chamber of Commerce, both ordinarily supporters of conservative economic policy. Along with labor leaders, who had been complaining from the beginning, these business spokesmen protested even more vociferously when the Fed -- acknowledging that it was now restraining growth -- went to 4 3/4 percent in August and 5 1/2 percent in November.

And another thing: those who, right from the start, back in February, said the Fed's actions would stop the expansion in its tracks have simply been proved wrong. Quarter by quarter, the economy has been growing more rapidly than almost anyone expected. By the fall, at close to 4 percent, the pace was faster than even most liberal economists believe can be sustained for long without inflation.

 One of the most important underreported points on the Fed's side of the argument is this: almost all economists, regardless of ideology, think it takes nine to twelve months before interest rate increases have their full effect on the economy. Thus, as Greenspan and other Fed officials explained over and over, their actions were not aimed at reining in the economy as it existed back in February or March or even November, but as they believed it would exist later on. The press initially took to calling the Fed's actions a "pre-emptive strike" against inflation, which was a useful characterization. But the term largely disappeared from the coverage later on, even though rate increases were voted, again and again, still without signs of here-and-now inflation, and few solid suggestions of inflation on the way.

 Assuming the estimate of a lag of nine to twelve months is correct, it is now time for the consequences of the Fed's series of interest rate increases to manifest themselves. If they don't, if the economy keeps growing at its current, hefty rate, that will constitute substantial support for the conclusion that the Fed was right all along: that the economy really was threatening to expand at a very high rate of speed back in February, when it began raising rates and trying to slow things down.

But that still wouldn't prove that accelerating inflation would inevitably have accompanied growth at that pace. Alan Blinder, for one, does not accept the view of Alan Greenspan and most of the other Fed policymakers that once the inflation rate starts to rise, it only keeps getting worse, nor their belief that inflation, once started, is much harder to reverse than a recession. The latter is perhaps Greenspan's most strongly felt argument for the preemptive strikes.

Those are all crucial points that have seldom shown up in places where ordinary readers would hear or see them.

Keith Bradsher of The New York Times Washington bureau is one of those who has repeatedly discussed with considerable sophistication, in business-section stories, the arguments against what the Fed was doing, as well as the arguments in support.

 But he has usually left the anti-Fed arguments out of his front-page pieces.

 He explains this on the ground that "the main question I have to answer the day the Federal Reserve acts is why the heck would they even dream of raising interest rates when the economy still hasn't produced jobs for seven and a half million Americans and when inflation is very low. The arguments why not tend to be more obvious to a general reader than the Fed's reasoning for doing it, which tends to require more explanation.

"Besides," he adds, "a strong demand exists [from Times editors] for the political context of interest rate increases, which tends to get short shrift in the business section stories . . . . There is also my own desire to put a rate increase in a context that not only business executives and bond traders will understand but also general readers, who may not pay attention to interest rates on a daily basis but may be very interested in politics."

Those are respectable arguments.

 But shaping economic policy stories by that logic, and presenting most of them only to a business audience, implies a belief that most readers care less about the economy than they do about Bosnia, for example, or welfare reform. It adds up to a philosophy of covering most of the economic news the same way journalism covers sports -- on the assumption that the people who really want to know the details will know where to find them. But informing the public about economic policy is more important than that.

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