A storied part of the Federal Reserve’s approach to combating financial crises was born in Russia a generation ago. The desire to insure against potentially disastrous outcomes for America’s economy — with dramatic shifts in interest rates, if necessary — is severely challenged today by Moscow’s invasion of Ukraine. The doctrine isn’t necessarily obsolete. It could, nevertheless, use a comprehensive update.
Risk management, monetary-policy style, was developed during Alan Greenspan’s 18 years atop the Fed and best exemplified by three rate cuts in late 1998 during Russia’s meltdown that year. It will be difficult to repeat that performance amid the current fraying international order, where the U.S. and its partners seek to isolate Russia. For one thing, legions of traders will have to learn to wean themselves from the so-called “Fed put”: the reassuring idea that whenever markets undergo stress — even if the overall U.S. economy is solid — the central bank will respond by easing or relaxing its stance.
Jerome Powell, the current Fed chair, inched toward a new kind risk management in testimony to Congress this week. Rather than shelve long-flagged plans to hike rates, Powell is stressing the need to proceed with the battle against elevated inflation. Like Greenspan, he is trying to look around the corner. At some point, the hostilities are likely to ebb, but inflation will still be there, the thinking goes. Powell doesn’t have the advantage of relatively contained price pressures that Greenspan did in the late 1990s. If companies and consumers come to expect high inflation, decades of hard-won credibility will evaporate. Powell’s endorsement of a quarter-point, rather than the half point speculated little more than a week ago, seems to acknowledge the perils of the moment. “We will proceed, but we will proceed carefully,” he told lawmakers Wednesday.
Powell is trying to manage risk in the face of a probable hit to growth from the surge in energy prices that accompanied Putin’s invasion. He is withdrawing pandemic stimulus, even if he isn’t moving fast enough for prominent economists like Lawrence Summers, who as deputy treasury secretary in 1998, played an important role with Greenspan in shoring up the American and world economies. The two men, along with then-Treasury Secretary Robert Rubin, were hailed on the cover of Time magazine early the following year as “The Committee to Save the World.” (Summers succeeded Rubin in July 1999.)
It wasn’t just how they navigated the Russia turmoil that deified the trio. Rescues in Thailand, Indonesia and South Korea preceded the calamity in Russia. Bailouts in Latin America followed. The approach, which fended off an implosion of the global economy, wasn’t without its dangers. “Greenspan realized that if there had been a meltdown, the headline would have read, ‘The Committee that Destroyed the World,’” Bob Woodward wrote in his 2000 book “Maestro: Greenspan’s Fed and the American Boom.”
By many measures, the U.S. economy was doing very well in the late 1990s. The dotcom boom was in full swing, unemployment was low and inflation behaved. The essence of Greenspan’s thinking about global upheavals was that, even if the Fed’s main projection was fine, the chance a flareup would wreck all that wasn’t zero. Better buy some insurance against a worse-case outcome.
The three rate cuts after Russia’s default, including a shock move between scheduled gatherings of the Federal Open Market Committee, altered the psychology of markets and how investors thought about economic policy. The Fed would almost always be there to catch you. Partners in the Group of Seven were enlisted to add their voice to calls to juice the global economy. I was a young reporter in the Washington bureau of Bloomberg News at the time, covering the International Monetary Fund. A few sentences one mid-October afternoon from the Fed announcing the inter-meeting rate cut sent markets soaring and achieved far more than months of painstaking deliberations at the IMF.
Greenspan described it in his 2007 memoir “The Age of Turbulence: Adventures in a New World,” as a new kind of trade-off for the central bank, one that had staying power:
“The way the Fed responded to the Russian crisis reflected a gradually evolving departure from the policy making textbook. Instead of putting all our energy into achieving the single best forecast and then betting everything on that, we based our policy response on a range of possible scenarios. When Russia defaulted the Fed’s mathematical models showed that it was highly likely that the U.S. economy would continue expanding at a healthy pace in spite of Russia’s problems and with no action by the Fed. Yet we opted to ease interest rates all the same because of a small but real risk that the default might disrupt global financial markets enough to severely effect the United States…Weighing costs and benefits systematically in this way gradually came to dominate our policy making approach.”
To say that Powell, and for that matter his counterparts at the Bank of England, European Central Bank and Bank of Japan, face turbulence is an understatement. Greenspan & Co. were helping shape the post-Cold War economic and political order. Powell, Christine Lagarde, Andrew Bailey and Haruhiko Kuroda must contend with its erosion, if not destruction. They are now wartime economic managers.
What committee will grace the cover of Time magazine next year, and for what will they be recognized, if not canonized?More From This Writer and Others at Bloomberg Opinion:
• Markets Have a Thin Safety Net Amid Ukraine Chaos: Daniel Moss
• Powell Threads Needle in a Swirl of Uncertainty: Jonathan Levin
• Pariah Status Will Exact a Toll on Russia: Ashworth & Gilbert
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.
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