Originally created 09/12/05

Greenspan's successor faces tough economic climate



NEW YORK - Not so long ago, it seemed like Alan Greenspan's successor as Federal Reserve chairman would have it pretty easy at first. The current economic climate of solid growth and tame inflation was expected to continue for many months to come.

That seems like a distant memory now that Hurricane Katrina has sent gasoline, heating oil and natural gas prices soaring and crippled major U.S. commerce hubs. At the same time, the housing market looks more fragile than it did before, causing even Greenspan to worry that the real-estate boom could be losing steam.

Greenspan, whose 18-year tenure ends in January, will leave behind a highly regarded and well-respected legacy as a strong inflation fighter. But his skills, and those of the successor President Bush will soon name, will likely be put to the test in the months ahead.

While Fed policy-makers have succeeded so far in keeping up economic growth while holding back inflationary pressures - some economists call it the "Goldilocks" economy: not too hot or cold but just right - by raising short-term interest rates 10 times since June 2004, some serious economic worries have emerged in recent weeks.

That's why some investors are now betting the Fed will slow or stop its campaign of interest-rate increases, especially after Hurricane Katrina and its destructive aftermath sent oil prices surging above $70 a barrel for a time and pushed gasoline prices above $3 a gallon in many parts of the country. That's expected to immediately affect consumer spending, which fuels two-thirds of economic growth.

Then there is the housing market, which has seen dramatic price gains in recent years thanks to the low-interest rate environment that was created by the Fed to jump-start the economy after the 2000 stock market crash and recession that followed.

Even though the Fed has kept bumping up short-term rates over the last year, the yield on the 10-year Treasury note - which is a benchmark for mortgage rates - has remained unusually low at around 4 percent despite the Fed's efforts, which continues to fuel the housing boom.

Greenspan in the past hadn't seemed overly concerned about the housing market overheating, but recently, his views appear to have changed. Using his strongest language yet, he told central bankers at a conference in Jackson Hole, Wyo., late last month that the "housing boom inevitably will simmer down. As part of that process, house turnover will decline from currently historic levels, while home price increases will slow and prices could even decrease."

Goldman Sachs economist Jan Hatzius suggested that is an important change of tone. "The chairman now sounds notably more worried than previously that house prices have risen too much and that the downturn could have a severe effect on the U.S. economy," he said.

Recent data supports the Fed chairman's concerns. Sales of existing homes retreated in July from June's record highs and the number of unsold homes rose, according to the National Association of Realtors.

Should the housing boom retreat at a time when oil prices are soaring, that could put more pressure on consumers whose spending has been fueled by the apparent increase in their real-estate wealth, not because of significant changes in their wage growth.

That potential double-whammy is sure to keep the Fed on its toes in the months ahead. Its policymakers had been expected to raise rates again when they meet later this month, but now many economists think they may hold off until they have a better gauge of Katrina's economic toll.

They also must closely watch the housing market, and decide whether it should influence monetary policy.

Greenspan has noted in the past that it is difficult for the Fed to identify a bubble before it bursts, but instead has the tools to stem the economic fallout once the collapse happens. But he suggested last month that the Fed might not be able to disregard the housing, stock or other asset price movements when setting monetary policy in the future.

"The sort of approach that they have now might not work anymore. They need to begin to bring asset markets into their thinking, and that will be something his successor must weigh," said Economy.com chief economist Mark Zandi.

While there isn't a front-runner yet emerging to take over for Greenspan, the challenges he or she will face are substantial. An end to interest-rate increases could trigger a new leg up for the housing boom and potentially higher inflation. But moves to keep increasing borrowing costs could slow the economy too much that it nears a recession.

Quite a way to start a new job.



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