SECTION: COMMENT & ANALYSIS; Pg. 13

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Facing up to a post-Greenspan future: Radical change after the retirement of the current Federal Reserve chairman
is possible - but unlikely

 BYLINE: By ALAN BEATTIE and PERONET DESPEIGNES

 The Bush administration recently made two nominations to the Fed's board of governors, reviving questions about whether Mr Greenspan's successors will have the
 same freedom to interpret its mandate and set interest rates as they see fit.

 Once a leader in many ways, including establishing independence from politicians, the Fed's style of policymaking has been overtaken by international trends in central
 banking. Many other central banks are adopting committees to set interest rates rather than trusting an individual. In contrast, power within the Fed is, in practice,
 concentrated around Mr Greenspan, partly because of his enormous personal credibility with markets and the public. Mr Greenspan's freedom of movement is further
 increased by the Fed's vague statutory mandate, simultaneously to support price stability, employment, and low long-term interest rates. This is much fuzzier than the
 numerical inflation target widely adopted elsewhere, from the Bank of England to the European Central Bank to emerging market countries such as Poland and Brazil.
 

 Few mainstream economists now believe there is a long-run trade-off between inflation and either growth or employment, implying the Fed's current mandate is
 unnecessarily complex.

 The intellectual currents in this general direction are strong. Steve Cecchetti, former chief economist of the New York Fed, says: "The debate is over, and the winners
 are those who want structured objectives given to central banks by legislators. The only question is how detailed those objectives should be."

 Inflation targets, their defenders say, also increase transparency and clarity within central banks, making their reactions more predictable and hence reducing
 uncertainty for investors, consumers and companies.

 Mr Greenspan has already gone some way to letting light in on the Fed's decision processes. First, he ended the practice of not telling the markets what the official
 interest rate even was or when it had changed. The Fed also bowed to pressure to inform observers about how it perceives the balance of inflationary and
 recessionary risks to the economy, and to publish committee votes and the minutes of the committee's meetings.

 But, while open to a more focused price stability mandate, Mr Greenspan has resisted the idea that adopting specific inflation targets or bands would lead to better
 policy. He told a Congressional committee in 1998: "Data showing a major advantage in very specific targeting procedures is unlikely to be forthcoming in any
 definitive way until we are able to demonstrate that countries that are on that sort of regime do show very much better behaviour than those who do not."

 Mr Greenspan is also suspicious of the reliability of the US consumer price index, likely to be used in any formal US inflation targeting regime, and concerned that
 technological changes in the economy can make price indices quickly obsolete. "For all these conceptual uncertainties and measurement problems, a specific
 numerical inflation target would represent an unhelpful and false precision," he told a conference at the St Louis Fed last October.

 Given his personal influence, this means radical change will almost certainly have to wait until he retires. This is an uncertain date, since his current term expires in
 2004 and he could, in theory, carry on after that until his seat is filled.

 However, recent nominations of two highly-regarded economists by President George W. Bush to the Fed's board of governors may influence the post-Greenspan
 era. One, Fed economist Don Kohn, is intellectually and personally close to Mr Greenspan. But the other, Princeton academic Ben Bernanke, is a supporter of
 inflation targets, which he portrays as a natural evolution of current practice. In a 1997 working paper, he wrote: "A major reason for the success of the
 Volcker-Greenspan Fed is that it has employed a policy-making philosophy, or framework, that is de facto very similar to inflation targeting." Formalising this
 framework "would increase the transparency of the Fed's decision-making processes, allowing more public debate of the Fed's strategy and, perhaps, reducing the
 financial and economic uncertainty associated with the Fed's current procedures".

 Mr Bernanke's nomination hearing could provoke a renewed discussion, including within Congress, where there is sometimes frustration with legislators' lack of
 influence over the Fed.

 The presence of monetary economists like Mr Bernanke on the Fed's board, plus the effect of a dominant individual moving on, also means that any new chairman
 will start off with a far less powerful position than Mr Greenspan.

 One White House economist says: "We wanted to build strength on the board and have some depth of analytic skills and independence of views so that the board
 can serve its traditional role. That's not very important with Greenspan, but it could be down the road."

 Any change is likely to be gradual. As a new appointment, Mr Bernanke is unlikely to create waves by pushing his point of view aggressively within the Fed. That is
 not the role the administration wants him to play, said the White House official: "It would be a mistake to say we somehow picked inflation targeting and that led us to
 Ben. We picked the person, not the issues."

 Moreover, introducing such a target is potentially hazardous. Given the decentralised nature of US politics, asking Congress to respecify the Fed's mandate is fraught
 with danger. One ex-Fed policymaker says: "Once you open up the legislation you might get anything back from Congress."

 The present calm on the US economic front also means there is little appetite for great upheaval.

 Adam Posen, a central banking expert from the Institute for International Economics in Washington, says for many countries adopting inflation targets first required a
 crisis when their monetary regime was ruptured beyond repair. Unless there is some major event, such as a truly savage stock market crash and a heavy recession, to
 cast doubt on the wisdom of having given Mr Greenspan such discretion over monetary policy, this seems unlikely in the US.

 According to Prof Alan Blinder, a former Fed vice-chairman: "My suspicion is that the Fed will snuggle up a little closer to inflation targets over time. You can imagine
 the Fed in about 20 years doing policy the way the Bank of England is now."

 LOAD-DATE: May 19, 2002