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As chairman of America's Federal Reserve Board, Alan Greenspan has earned a formidable reputation as a wise central banker. That reputation is about to be put to the test again
"ALAN, to pay tribute to you as the central banker of the year would seem to be an understatement. Central banker of the decade would be more appropriate." Thus Hans Tietmeyer, boss of Germany's Bundesbank and no monetary lightweight himself, when Mr Greenspan was recently named "Policymaker of the year" by International Economy magazine.
The praise is well-deserved. In his eight years at the helm of the Fed, Mr Greenspan has been an exemplary manager of America's monetary policy. Thanks largely to his "pre-emptive strike" in early 1994, when interest rates were raised early to stop any resurgence of inflation, the American economy is enjoying one of its longest cyclical recoveries, and with continuing low inflation. The widely cited "misery index"--the sum of the country's unemployment and inflation rates--has fallen to one of its lowest recent levels (see chart). But as Mr Greenspan prepares for his third term as the Fed's chairman, he faces some formidable challenges.
Steering the right course on interest rates is particularly tricky at the moment, not least because the American economy is proving surprisingly resilient. On June 7th the bond market tumbled on news that the number of new non-farm jobs being created (a widely quoted indicator of the state of the economy) was a robust 348,000 in May. Many economists are now forecasting that GDP will rise at an annual rate of 3-4% in the second quarter of 1996--well above the rate of a little more than 2.5% that the Fed thinks can be sustained without fuelling inflation.
This suggests that interest rates need to rise. But pushing for tighter monetary policy now, with a presidential election only a few months away, will take a lot of political courage. Any rise is bound to infuriate President Clinton, who recently made one of his rare pronouncements on monetary policy: on the day that the latest jobs figures were released, he said that he saw no need to raise interest rates right away.
To complicate matters, the Senate has yet to confirm Mr Greenspan's own reappointment for a third term of office. His renomination (as well as confirmation of the appointment of Alice Rivlin, who is due to become vice-chairman of the Fed, and Laurence Meyer, who has been put forward as a new governor) has been held up by Senator Tom Harkin, a Democrat, who thinks that the Fed's monetary policy has been far too tight and wants a debate on the issue. Until the Senate has reconfirmed him, Mr Greenspan will be loth to antagonise Mr Harkin and others who think that the economy can grow safely at a faster clip. So staging the same pre-emptive strike against inflation that he did two years ago is going to be difficult.
Although monetary policy is undoubtedly the biggest headache for Mr Greenspan, it is not the only one. The Federal Reserve is facing fresh challenges on other fronts. Banking supervision is one. This week, Jim Leach, chairman of the House banking committee, at last admitted defeat and dropped his attempt to push through legislation to repeal the Glass-Steagall act, which separates America's commercial banking and securities industries.
This setback means that the onus will now be on the Fed to continue to relax the regulations by administrative fiat instead. It has already hinted that it is willing to do this by, say, gradually increasing the percentage of revenues that banks are allowed to earn from securities trading and underwriting. But this is likely to earn the Fed the ire of the very same lobbies (notably the powerful independent insurance agents, who want to restrict banks' insurance powers) that helped to scupper Glass-Steagall reform.
A series of other embarrassing incidents this year also suggest that Mr Greenspan may face a managerial challenge at the Fed. In January, for example, Henry Gonzalez, the former Democratic chairman of the House banking committee and a long-time critic of the Federal Reserve, claimed to have uncovered "serious problems" in the Fed's air transport of cancelled cheques. He alleged that the Federal Reserve Bank of Boston (one of the 12 regional reserve banks in America, and the bank responsible for flying cheques around the country) had failed to use competitive bidding when hiring freight companies.
Then in April, the General Accounting Office (GAO), a congressional watchdog, issued a draft report that complained of a dramatic increase in administrative costs at the central bank. In early June Mr Gonzalez struck again. This time he reported that the Los Angeles branch of the Federal Reserve Bank of San Francisco had been supplying incorrect figures in its weekly currency-handling reports. Los Angeles, which has the biggest cash-counting facility in the Federal Reserve system, seemed to have made errors worth a total of $178m (though they netted out to a "shortage" of $55m). While separate daily accounts were correct and no money actually went missing, the case has raised questions about the quality of the Los Angeles branch's management.
On the defensive
The Federal Reserve dismisses this mishap as trivial. In response to the GAO report, Mr Greenspan claimed that his organisation was "extraordinarily well-run". Certainly, by the standards of other central banks, the Federal Reserve system is both open and accountable. In general, the regional reserve banks also seem to be efficient money-handling factories.
But America's central-bank system nevertheless needs restructuring. Its present form reflects the political and economic realities of 1913, when it was first set up. The 12 regional Feds operate as private institutions, overseen by the publicly appointed officials of the Federal Reserve Board in Washington. Their location bears little resemblance to the distribution of economic power in America today. The north-east has too many banks (Boston, New York, Philadelphia, even Cleveland). Missouri is worse still: it has two of the 12 regional banks, reflecting a 1913 deal to secure a crucial Missouri senator's approval for the act. Meanwhile California has only one, to deal with the whole of the west. Redistributing the banks would surely make sense.
Regional Fed bosses are neither elected nor publicly appointed: they are chosen by private citizens who sit on the boards of their banks, subject to the approval of the Fed's governors. Yet they have considerable power. Individual presidents can and do express opinions freely on a wide range of issues. For instance, Thomas Hoenig, president of the Kansas City Fed, is well-known for advocating a radical redesign of banking regulation, at least for some large banks--a view shared by few of his colleagues.
The regional governors also play a powerful policy role. The president of the New York Fed and four other regional bosses (in rotation) sit with the seven governors of the Federal Reserve Board on the Federal Open-Market Committee (FOMC), which is the body that sets monetary policy.
This apparently unaccountable power worries some congressmen. Mr Gonzalez, for instance, thinks that the regional presidents should be appointed by the president. Senator Paul Sarbanes and Representative Lee Hamilton, both Democrats, want to end the regional presidents' right to vote on monetary policy. One undesirable consequence of this, however, is that it might make the Fed softer on inflation, since regional presidents tend to be the more hawkish members of the FOMC.
In any case, there is little enthusiasm for dramatic reform. The view that prevails at the Fed and among most congressmen seems to be: "If it ain't broke, don't fix it." Mr Greenspan's fine record on monetary policy makes that seem plausible. But, assuming that he is granted a third term, Mr Greenspan could make his mark on the Fed indelible by undertaking the structural reorganisation that is long overdue.
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