Buckle up for Fed's try at another `soft landing'

The Economy


For those of us who've traveled abroad, as we near the end of the long flight home, we invariably hope for a nice, soft landing rather than one of those gut-jarring touchdowns that leaves passengers with fear in their eyes.

If you have any interest at all in the current state of the economy - and who doesn't these days? - you might be worrying about the kind of landing we face. The U.S. economy is in its record 120th-straight month of growth, which means we've enjoyed a spectacular journey.

As we begin the homeward leg of our sojourn, Federal Reserve Chairman Alan Greenspan is the captain at the controls of our "New Economy" flight. Will we have a soft landing - defined by slower, but sustainable economic growth? Or are we in for a hard landing - underscored with the pain of recession and the resurgence of downsizing?

Among economists, there's near-universal agreement that Greenspan has been the greatest Fed chief in the nation's history. Greenspan's mastery of monetary policy and his deft management of the U.S. financial system allowed us to dodge the fallout of the 1987 stock market meltdown and inoculated the U.S. economy against infection by the "Asian flu" in 1998. But when it comes to soft landings, some economists say that even the great Greenspan is only one for two.

"History shows that the Fed is rarely successful when it comes to achieving a soft landing," says Steve H. Hanke, professor of applied economics at the Johns Hopkins University and chairman of Friedberg Mercantile Group Inc., a currency-trading house.

A soft landing is when the Fed boosts short-term rates enough to slow the economy to a steady, sustainable pace, striking the perfect balance between inflation and recession. As history also shows, achieving that economic nirvana demands foresight, fortitude - and luck.

Like the World War II best-seller of a similar title, God was Greenspan's co-pilot between 1994 and 1995, when he blocked out the cacophony of dissent from doubting-Thomas economists.

As the U.S. economy recovered from the 1990-1991 recession, it began to zoom, and Greenspan feared inflation would result. The central bank raised rates seven times between February 1994 and February 1995. Economists screamed in feigned pain with the last one - and the economy slowed enough that Greenspan & Co. were able to begin loosening credit by that July.

The vaunted Fed chairman hadn't been as lucky earlier in the decade, however, when the central bank's tight-money stance led indirectly to the 1990-1991 recession.

In early 1988, only months after stocks crashed, the Fed began boosting rates to repel a resurgence of inflation. It moved aggressively, raising rates by 3 percentage points between February 1988 and February 1989, which took the benchmark federal funds rate to 9.75 percent.

By mid-1989, hoping to achieve the nirvana balance, the central bank reversed course, and began cutting rates. Those rate reductions were possibly too little, too late, because of a development over which the Fed had no control - Iraq's invasion of Kuwait on Aug. 2, 1990. That invasion sent oil prices to $39.50 a barrel. On top of still-tight credit and the likelihood of war, this oil spike helped "shock" the economy into recession.

"Just when a soft landing was either going to happen or not happen, we ended up in a war," says Joel Naroff, president of Naroff Economic Advisors, a forecasting firm in Holland, Pa. "It sharpened oil prices and created uncertainty. We called it the `CNN Effect.' Instead of people being out in the malls shopping they were at home, watching the war. It's unclear whether he could have pulled it off."

Whether he can "pull it off," is what economists are wondering. The Fed's policy-making arm has raised short-term rates six times since June, including the larger-than-usual, half-point increase this month.

Many Fed-watchers believe that Greenspan feels pressured to conclude his rate increase before the presidential campaign gets serious in the fall. That could mean that, instead of waiting to gauge the impact of what's been done, he may advocate rate increases at one or both of the Fed's summer meetings, in June and in August.

Even if the Fed holds the line on rates, there's always the risk - though probably small - that it's gone too far already. Although the initial effects of a rate increase are visible as soon as six months after the move is made, the real impact isn't seen for 12 months or more, many experts say. And only 11 months have elapsed since June 30, when the Fed first raised rates.

With credit tight and the economy vulnerable, there's always a risk that something unforeseen could send the economy into a nosedive. This shock could come from anywhere. For instance, with so many consumers invested in stocks, many market watchers wonder if a share-price plunge would prompt shoppers to snap shut their wallets, depriving the economy of its fuel.

And finally, the U.S. economy Greenspan is piloting isn't the same one he brought in for a soft landing five years ago. Its fortunes are more than ever linked with those of the stock market, with foreign economies, and with a financial system stuffed with complex instruments like derivatives.

Still, many economists refuse to bet against Greenspan, figuring he'll engineer that soft landing - and several years more of prosperity - even if it's on a wing and a prayer.

"We've really had a great, great decade," says Naroff. "Is a soft landing possible? Maybe."

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