How does Federal Reserve chairman Alan Greenspan decide to raise rates a quarter point? By analyzing a potent mixture of raw pecuniary data and computerized economic intelligence against first-hand reports from key hubs of U.S. financial activity and five
Howand whydoes the Federal Reserve chairman decide to raise interest rates? By analyzing statistical indicators and raw data on the health of the U.S. economy. By pulling together reports of the Fed, governors and bank presidents. Then, by tossing in anecdotal insightsreal-time informationfrom hubs of U.S. manufacturing, distribution, retailing and financial activity. Add 25 years of experience, and you get a knowledge management system that corporate leaders covet.
The Nations Economic Health was glowing. Unemployment held steady at 5.4%. Gross domestic product growth was up 4.4% and inflation remained in check at 3%, compared to a year earlier.
Still, Alan Greenspans brow creased with concern.
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As 2005 began, he was getting sometimes conflicting reports from the other six governors of the Federal Reserve Board and the presidents of the 12 Federal Reserve Banks across the country.
Snarls had ended at the Los Angeles and Long Beach ports, where, prior to Christmas, huge container ships sat backed up in the harbors for as many as 6 1/2 days, reported Janet Yellen, president of the Federal Reserve Bank in San Francisco. Shipments of everything from toys to big-screen TVs from China were now moving smoothly out of the ports to retailers across the country.
Four hurricanes had whipped Florida in the fall. That took bites out of consumer spending as homeowners paid more for insurance deductibles and tourists stayed away. However, job growth looked strong in the region overseen by Jack Guynn, president of the reserve bank in Atlanta. Unemployment had dipped to 4.5% in December, from 4.9% a year earlier.
The Midwest was a mixed bag. Automobile production had surged 2.3% in December, capping a year that saw auto production accelerate 3.2%. But steel prices, which had doubled to about $630 a ton for hot-rolled sheets, were now hurting manufacturers in the smokestack region overseen by Michael Moskow, president of the reserve bank in Chicago.
Fed chairman Greenspan had to make sense of these tales and the data behind them at the Feb. 1 meeting of the Federal Open Market Committee. He leads that Federal Reserve body, which guides U.S. interest rates and monetary policy.
He would mentally compare the governors and presidents assessments and anecdotal reports against the reams of economic data analyzed for him and the other board members by the Feds 225 economists and those at the 12 Federal Reserve Districts. Some of the countrys brightest minds have tilled data at the Fed for more than two decades, including research-division director David Stockton and banking-research chief Thomas Brady.
In the weeks before the Feb. 1 meeting, Fed financial experts pored over every available economic statistic, big and small, from corporate profits to industrial production to the Producer Price Index, which measures the change in prices manufacturers receive for the products they make.
What would Greenspan do? Inside his brain would be calculated the most likely impacts of all the colliding data. Once again, as it had been for more than 17 years, it would be his job to make choices that would keep the economy growing. If he raised interest rates more than the quarter percentage point the market was expecting, businesses might rethink their expansion plans for the year, eliminating thousands of jobs. If he didnt raise rates, inflation could take flight as consumers and businesses took advantage of the low cost of borrowing money.
On yellow legal pads, the same ones he uses to jot down thoughts when he takes his morning bath, the chairman had added up the inputs and determined that the economy was on a roll. But to stave off inflation, it was time to increase the Federal Funds Ratean overnight bank lending rate that influences rates on mortgages, car loans and many other loansanother .25%, to 2.5%. It would be the sixth quarter-point increase since June 2004.
Greenspan figured his measured move would keep inflation in check at an acceptable 3.4% over the next year. It would also give the Fed some breathing room. If signs of a slowdown emerged, he could lower rates to stimulate the economy.
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"All told," he testified before Congress two weeks later, "the economy seems to have entered 2005 expanding at a reasonable pace, with inflation and inflation expectations well anchored." The normally opaque Greenspan even smiled that day.
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