A glimpse at the post-Greenspan Fed

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After the Federal Open Market Committee’s Jan. 31 rate announcement, there will be a new chairman at the helm. This is a true changing of the guard, with Ben Bernanke stepping in to fill the shoes of the legendary Alan Greenspan.

Greenspan has been the Fed chairman since Aug. 11, 1987, more than 18 years as the head coach of the world’s largest economy. That reign has encompassed two recessions, a global financial crisis, the dot-com bust, Sept. 11, corporate accounting scandals and 45-year lows in interest rates.

Despite that, the Greenspan era has seen the economy nearly triple in size, the Dow Jones industrial average quadruple, and both interest rates and inflation decline. Today’s yield on the 10-year Treasury note is about half of the 8.7 percent it was when Greenspan became chairman, meaning both corporate and consumer borrowing costs are now significantly lower. All the while, Greenspan engineered greater Fed transparency, from introducing announcements of Fed rate changes to issuing a post-meeting statement and the near-telegraphing of intentions prior to Fed moves as a way to limit market volatility.

Many questions are bound to arise as a result of the change in Fed chairmanship.

Is greater market volatility a likelihood until investors worldwide develop confidence in Bernanke’s abilities? This is certainly possible. Recall that just two months after stepping in as Fed chairman, Greenspan was confronted by the Black Monday stock market crash of Oct. 19, 1987, when the Dow lost nearly 23 percent of its value in one day. The Greenspan Fed was quick to cut interest rates in response, with the stock market and economy rebounding afterward.

While Greenspan has sparked transparency by the Fed, Bernanke might take a further step, favoring a specific inflation target. We might see the Fed name a specific, tolerable inflation threshold in the future, and should current inflation pressures intensify, we might see an inflation target sooner rather than later.

But where does the Fed go from here in terms of interest rates?

Although a Jan. 31 interest rate hike is expected, the burning question is whether they will hike further at upcoming meetings.

Bernanke’s first FOMC meeting is not until March 28. The outlook could be decidedly different by then for a Fed that is currently giving increased weight to incoming economic data.

With concerns about inflation, the housing market and consumer spending, the two months between Greenspan’s last hurrah and Bernanke’s debut as Fed chairman will bring two full cycles of economic data. This two-month period will be a valuable window to assess whether economic growth is slowing too fast, if inflation will force the Fed’s hand or a housing slowdown jeopardizes consumer spending.

The Fed statement we see on Jan. 31 might offer few clues as to what interest rate moves we see in March and beyond. Some of that is due to the change in Fed leadership. But even more is attributable to the increased importance of fresh economic data as the Fed closes in on the end of interest rate increases. The interest rate questions will remain unanswered as long as the economic questions persist.