What Would Greenspan Do? Bernanke Weighs Risks of Rate Increases and
By GREG IP WSJ May 22, 2006; Page A2 REMAINDER:
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After a string of interest-rate increases, the U.S. economy is starting to
soften, but inflation is edging higher. That poses a dilemma for new Federal
Reserve Chairman Ben Bernanke: Should the Fed worry more about rising
inflation and raise rates further, risking a recession? Or should it worry
more about growth and hold rates steady, risking higher inflation and a loss
of credibility? The outlook for global stock and bond markets will hinge on
the outcome of that decision.
It is a situation similar to what his predecessor, Alan Greenspan, faced
three times in his 18 years as chairman, in 1989-90, 1994-95 and 1999-2000.
In each case, he stopped raising rates before inflation peaked. Two episodes
resulted in recession, one in a growth slowdown; in each, inflation
ultimately ended lower than it began.
"This is a problem central banks have wrestled with for many, many years,"
said Mark Gertler, a monetary economist at New York University. A 1995 study
of historical experience he wrote with Mr. Bernanke, then a Princeton
University academic, found that economic growth begins to slow roughly six
months after the Fed tightens monetary policy. But inflation doesn't begin
to ease until about year has passed.
The result often is an uncomfortable period when growth is slowing,
inflation rising and the central bank facing a tough choice between higher
rates and watchful waiting.
That may be where the U.S. economy is now. After a first-quarter surge,
growth is slowing, as higher interest rates and energy prices take their
toll on housing and consumer spending. It "seems pretty clear that the
housing market is cooling," Mr. Bernanke said Thursday, though the slowdown
is quite "orderly and moderate." But core inflation, which excludes food and
energy, reached a one-year high of 2.3% in April...