ROANOKE TIMES
Copyright (c) 1996, Roanoke Times
DATE: Sunday, October 27, 1996 TAG: 9610250035
SECTION: BUSINESS PAGE: 1 EDITION: METRO
DATELINE: WASHINGTON
SOURCE: JOHN R. WILKE THE WALL STREET JOURNAL
What will the Fed do next?
Don't ask Australian Treasurer Peter Costello, who roiled world markets recently when he was supposed to have said Federal Reserve Chairman Alan Greenspan wasn't very worried about inflation.
Never mind that the story was secondhand and probably wrong. A few weeks earlier, stocks dropped after Fed Governor Janet Yellen declared the economy in an ``inflation danger zone.'' Traders had forgotten that she had said the same thing, widely reported, only three days earlier.
No nugget of news is too trivial for the frenzied handicapping of Fed moves. Comments by second-string officials rattle traders from Kuala Lumpur to London. So do routine economic statistics, with good news perversely upsetting securities markets. And theories for predicting Fed action fade in and out of fashion.
``It's gotten out of hand,'' says Alan Blinder, a former Fed vice chairman. He says the question he is asked most often since leaving the central bank is what number the Fed watches most closely. ``People are always searching for the Holy Grail, the magic statistic that swings the Fed,'' he says.
It's a moving target. Years ago, Fed economists tracked corrugated-box sales (a lot of stuff is packed in boxes). More recently, Greenspan's command of obscure statistics has ranged from scrap metal prices (often rising in good times) to railroad car loadings (they also move stuff). And with nothing more than an off-hand comment at a congressional hearing, he has vaulted to market-moving status such arcana as the diffusion index of supplier-delivery lags (how long it takes for raw materials to reach factories). The dollar, the trade deficit, the price of gold and, most recently, the monthly unemployment report have taken center stage.
Sure, the Fed could peg its policy to some easily understood goal, like an inflation-rate target, as some at the Fed now advocate. But it wouldn't be as much fun, it might deliver a warning too late, and it probably wouldn't please the enigmatic Greenspan, who prefers to read the tea leaves and keep his options open.
In the early 1980s, Fed policy was tied to the money supply. So, the weekly release that follows a variety of monetary statistics, especially one called M2, was a white-knuckle moment in the markets. Now, the thrill is gone. Reporters still gather every Thursday afternoon at the New York Fed for a closed briefing, awaiting the appointed moment for flashing the figure worldwide. But M2 doesn't move markets because economists have decided it doesn't indicate as much anymore.
``The whole M2 thing is vestigial - it's dull,'' says a reporter who covers the New York Fed and asked for anonymity because ``I don't want my editor to catch on.'' To liven up one briefing, a Fed official shared photos of his Grand Canyon vacation.
More complicated theories predicting Fed action also come and go. Currently fashionable is the Taylor Rule, courtesy of Stanford University's John Taylor. It weighs reported economic growth against potential or ``sustainable'' growth and inflation, yielding an estimate of the appropriate federal-funds rate, the rate on bank-to-bank loans. But what you get out of the equation depends on what you plug into it. And no one can be sure just what to plug in.
Another is the Phillips Curve - a trade-off between suffering inflation and suffering unemployment - and a related beast called the NAIRU, the nonaccelerating-
inflation rate of unemployment - the point where too much prosperity starts to drive up prices. But the supposed links between inflation and unemployment have turned squishy in the past year or so, making the theory's predictions unreliable.
Lately, the Fed has been testing the inflation risks stemming from ever-lower rates of unemployment by holding policy steady despite strong economic growth. This drives Wall Street crazy, humbling its highly paid economists and repeatedly forcing them to scrap forecasts. Phillips-curve aficionados insist that the theory remains valid and just needs to be recalibrated - yet again.
Still-another tactic, called opportunistic disinflation, lacks much predictive value but prescribes a pragmatic approach. It holds that if inflation is relatively low, the Fed shouldn't relentlessly try to push it lower but rather should wait for the next recession to reduce it. But the theory also urges the Fed to get tough before inflation rises. Unfortunately, it doesn't indicate when inflation will rise and thus when the Fed should or will raise interest rates.
Other recent theories have fallen from favor. P-Star, which used money-supply growth to predict price pressures, was briefly famous - its esoteric formula even got into newspapers. While this onetime Greenspan favorite has gone the way of other money-supply theories, the Fed chairman titillated true believers recently when he told a congressional hearing that M2 may be making a comeback.
The frenzy to handicap the Fed is partly due to a proliferation of financial newswires, interest-rate futures markets and hedge funds. The dirty secret is that ``they all have a vested interest in volatility,'' says H. Erich Heineman, a New York economist. It doesn't matter whether rumors are false or data misleading - if they move the market, that's enough, he says, because a lot of people still get paid.
Fed mania isn't confined to Wall Street. Anthony Solomon, a former New York Fed president, says the Fed now pops up in elevator conversations and at the doctor's office. With the huge rise of mutual-fund holdings, he says, ``everyone has an opinion'' on Fed policy.
Pearl Gellin, a retiree in West Hartford, Conn., says she is delaying rolling over a savings certificate until she can figure out which way Greenspan is leaning. And she suspects that he is confused, too. ``I think he wasn't really sure what to do, what with the economy changing so much,'' she says.
At Cossack Caviar in Arlington, Wash., owner Gary Shaw recalls waiting nervously for results of the Fed's Sept. 24 meeting. ``We were hoping they wouldn't raise rates because we thought it'd drop the market,'' he says. Most of the caviar company's profit-sharing plan is in stocks, ``and we were pretty scared, with all the conflicting predictions,'' he adds.
Amateur Fed watchers were treated to a melodrama last month when a split between regional Fed bank presidents and Fed governors in Washington spilled into the open with a Reuters report that eight of 12 presidents wanted higher interest rates. Insiders discerned an effort to pressure the chairman, who thought the economy would slow down on its own.
However, the Reuters story wasn't any help in predicting the Fed's decision; neither was an earlier Wall Street Journal article quoting officials who forecast a stiff rate increase. When the Fed met Sept. 24, it held rates steady, mocking the wild market swings of the preceding weeks.
No matter -- there's always next month. The Fed meets again Nov. 13.
LENGTH: Long : 122 lines ILLUSTRATION: PHOTO: (headshots) Greenspan.by CNB