Originally created 09/01/01

Fed chairman says new economic formulas are needed

WASHINGTON -- As the Federal Reserve tries to revive the economy, chairman Alan Greenspan said Friday it's difficult to determine the effects of gyrating stock market and home values on the economy's lifeblood, consumer spending.

And that, analysts said, is complicating the Fed's job of conducting monetary policy, which involves lowering or raising short-term interest rates to spur or slow economic growth as required.

Consumer spending accounts for two-thirds of economic activity in the United States and has been a main force keeping the nation out of recession. The yearlong economic slowdown has led to a slide in the stock market, but home values, for the most part, have gone up.

"There can be little doubt that sizable swings in the market values of business and household assets have created important challenges for policy-makers," Greenspan said in a speech at the Fed's annual retreat in Jackson Hole, Wyo.

To assess how gains or losses from different types of assets - a stock versus a home - affect consumer spending, and thus the overall economy, will require more analysis, Greenspan said. New measurements also may be needed.

"To answer these questions, we need far more information than we currently possess about the nature and the sources of capital gains and the interaction of these gains with credit markets and consumer behavior," he said.

Economists agreed with Greenspan's assessment that policy-makers need to get a better handle on such relationships.

"The stock and housing markets are playing an increasingly important role in how we behave as consumers and businesspeople and thus play a more important role in determining how monetary policy is conducted," said Mark Zandi, chief economist at Economy.com.

Greenspan's remarks come against the backdrop of an economy in which growth has slid close to recession this year and amid criticism that monetary policy under Greenspan has lost some of its punch.

Lynn Reaser, chief economist at Banc of America Capital Management, viewed Greenspan's remarks as supporting the notion that monetary policy remains an effective tool.

"The Fed needs to understand the linkages more clearly between changes in home prices and stock prices and their impact on consumer spending and may need to have better data to make monetary policy," Reaser said. "Monetary policy may still be very effective, but it is operating in a more uncertain framework."

Separately, orders to U.S. factories rose by a bigger-than-expected 0.1 percent in July, following a 2.9 percent drop the month before. The gain reflected stronger demand for cars, furniture, household appliances and communications equipment.

Over the past 18 months, Greenspan noted that home values have gone up while stock values have contracted significantly.

In those circumstances, he said, differences in people's tendencies to spend on the basis of capital gains and losses on different types of assets "could have significant implications for aggregate demand."

In general, for every $1 increase in wealth, people spend three to five cents more, he said. When a home is sold, he said, consumers tend to spend more with the cash from their capital gains, 10 cents to 15 cents of each dollar.

Yet, Greenspan said capital gains on stocks and mutual funds in recent years have been two to four times the size of overall gains on homes. "The sheer size of such gains suggests that capital gains on equities have been a more potent factor in determining spending than gains on homes," he said.

In his speech, Greenspan did not speak about the future of the overall economy nor of the Fed's interest rate policy. It has slashed interest rates seven times this year in an effort to avert the first recession in the United States in 11 years.

On the Net:

Greenspan speech: http://www.federalreserve.gov/boarddocs/speeches/2001/20010831/defau lt.htm


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