When Alan Greenspan sat in front of the politicians in Congress back in February 2005, he purposefully made it seem like what was taking place at that time was some kind of new and unusual development. Yeah, the guy who had previously become famous for fedspeak – the ability to use a lot of words while saying nothing – would regularly slip right out of it whenever it suited his purposes.
Those were inflation, back in early ’05. Already people were growing nervous, something about house prices and how these were being financed. The Fed’s job, like those at the “central bank” saw it, was to influence behavior so that neither the economy nor the financial system moved too far in either direction – inflation or deflation.
Keep everything right down the middle, as seemed to have suited everyone in the Great “Moderation” of the nineties.
But how does this work, specifically? And how do we tell if it is, or is not, working?
What the “maestro” didn’t say in Congress was anything at all about the monetary system. Inflation or deflation, both were and will always remain monetary diseases yet in what would end up being some of his most memorable testimony Alan Greenspan never said the word “money” once; not a single mention in his prepared remarks.
He did manage to say “inflation” fourteen times, however.
The relevant background: the dot-com recession of 2001 had been especially mild yet the “jobless recovery” from it nearly cost George W. Bush his 2004 reelection. Policymakers at the Fed already perplexed by this went to “extraordinary” lengths cutting their fed funds target all the way down to one percent in June 2003 – almost two years after the recession had ended.
One year later, in June 2004, the economy picked up, the labor market accelerated and Bush was soon back in the White House.
With the fed funds target still at 1%, Greenspan and his staff of Economists began to consider whether or not they’d done too much; worried they had erred too far on the side of dot-com bust and deflation (which was never a real risk).
So, the doves turned hawks and rate hikes started up and continued one after another after another.
Not even a year into the cycle, however, again Economists were stumped. The Fed was raising rates but LT bond yields just weren’t buying it; on the contrary, the bid for safety and liquidity confounded these rate hikes. As Chairman Greenspan claimed while at the Capitol, the yield curve, “can be thought of as an average of ten consecutive one-year forward rates.”
Therefore, the Fed starts hiking and the entire yield curve is expected to respond, to dutifully obey what everyone including Congress has been told is its master, Master Alan. This wasn’t happening.
This content was originally published here.