Once even ‘maestro’ Greenspan was a greenhorn

With markets on edge and reacting violently to every hint that the US Federal Reserve might be shifting its stance on monetary policy, some are drawing unfavourable comparisons between the final years of Alan Greenspan’s tenure as chairman and Ben Bernanke’s first four months as Fed chief.

“Bernanke has not been as sure-footed on communications as I would have expected,” says a strategist at a leading financial institution, expressing views widely shared by investors.

Allan Meltzer, a professor at Princeton University, says Mr Bernanke has not made any obvious policy mistakes, but is struggling to explain his thinking to the market. “I think he is off to a rocky start.” But Fed watchers viewing events from the long sweep of history, including Prof Meltzer, say that a fairer comparison might be with Mr Greenspan’s own early years as Fed chairman, when the man later dubbed “the Maestro” was equally tested and doubted by the markets.

In August 1987, only three weeks after Mr Greenspan took over as Fed chief, the dollar started to slide and long-term US bond yields began to surge. Mr Greenspan raised interest rates in September but soon afterwards the dollar resumed its slide and bond yields rose to almost 10.5 per cent before the stock market crashed on October 19.

Mr Greenspan’s expert handling of that crisis was the first building block in the construction of the Greenspan legend. But at the time, commentators said Mr Greenspan was handicapped by lacking the credibility of his predecessor, Paul Volcker.

John Berry, then a correspondent for the Washington Post, wrote: “Greenspan has paid a price for not being Volcker. Despite Greenspan’s long support for strong anti-inflation policies... financial market participants could not be sure how he would perform in his new job. Volcker, on the other hand had, after eight years as chairman, achieved demigod status in the eyes of many market participants.”

Nor was Mr Greenspan known from the start for the remarkably self-assured communication that marked his later years. Prof Meltzer says that at the start of his chairmanship, Mr Greenspan puzzled the market by appearing to adjust interest rates in response to changes in unemployment levels. His reputation as a master communicator came after 1994, when the Fed moved to a regular interest-rate setting cycle, with Mr Greenspan guiding market expectations between meetings.

Compared with Mr Greenspan’s baptism by fire, Mr Bernanke has had a relatively unturbulent start. But he has taken over at a difficult stage in the cycle, when the Fed itself is uncertain how the economy will evolve.

The combination of a new Fed chief and uncertain fundamentals has led to an uptick in inflation expectations and a sharp increase in market volatility on days when Mr Bernanke speaks or the Fed issues statements or minutes.

Prof Meltzer says Mr Bernanke has made mistakes in communication. “He has been shifting his position from being a little bit more dovish to a little bit more hawkish as the numbers change.” Prof Meltzer suggests Mr Bernanke should explain very clearly to the market that he cannot do anything about current inflation data and will focus purely on the medium-term inflation outlook.

But as long as the Fed avoids making actual policy mistakes, he adds, there is nothing to stop Mr Bernanke recovering from communications mis-steps and starting to build his own market reputation.

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