How Long Will The Good Times Roll?

Alan Greenspan is finishing a decade as chairman of the Federal Reserve in high style with the economy and the stock market both racing ahead.

But, as he prepares to deliver his midyear report to Congress today, he must deal with the nagging question of how long the good times can last.

With the current economic recovery already the third-longest in U.S. history, Congress will be probing for assurances that Greenspan and his colleagues at the Fed won’t repeat previous policy mistakes. Both the two previous-record expansions - in the 1960s and 1980s - were ended by Fed policy miscues.

“Inflation still remains the most likely threat to end this expansion,” said David Wyss, an economist at DRI-McGraw Hill Inc. “The danger is that the Fed will not tighten soon enough and inflation will gradually begin to rise - just as it did in the 1960s and late 1980s - and that will create the imbalances that bring on the next recession.”

But for the moment, economists concede, inflation is nowhere to be seen. Core consumer prices rose at an annual rate of just 2.4 percent in the first six months of this year, the most stable prices since 1965.

That good performance came as the economy grew at the fastest pace in a decade during the first quarter of the year and unemployment fell to a 24-year low of 4.8 percent in May.

Confronted with rapid growth and tight labor markets, the central bank normally would be raising interest rates to slow the economy and keep inflation under control.

The Fed did make one pre-emptive move against inflation in March, a tiny, quarter-point increase in the key federal funds rate, the interest rate banks charge each other. But Fed policy-makers passed up chances to raise rates further at May and July meetings even though it was apparent the economy was exceeding the Fed’s speed limit.

That has led to talk that Greenspan, the staunch Republican conservative first appointed chairman by President Reagan in 1987, has suddenly become a devotee of the “new economy.”

Supporters of this view argue that increased global competition and improved productivity of U.S. businesses mean the economy can grow at a faster rate with lower unemployment than previously believed without higher inflation.

While politicians find this view attractive for the obvious reason that it supplies a rationale for keeping interest rates and unemployment rates low, many Fed observers believe Greenspan will continue to voice skepticism about whether the economy really has entered a new age.

“Greenspan does not want to promote the view that he has become less pro-active against inflation,” said Sung Won Sohn, chief economist at Norwest Corp. in Minneapolis. “He wants to put the fear of inflation and the fear of a Fed tightening back into the minds of investors.”

Greenspan’s tough talk on inflation could be followed by action, at either the August or September meeting, analysts said, if signs develop that the economy is not slowing enough.

Analysts also believe Greenspan continues to be uneasy about the huge run-up in stock prices. The Fed chairman rattled markets around the world last December when he mused about “irrational exuberance.” And since then the Dow Jones average has climbed another 26 percent, breaking through the 8,000-milestone last week.

Only twice before have stocks soared as they have this year after huge run-ups the two previous years, worriers note - in 1929 and 1987. The 1929 surge ended with the October crash that brought on the Great Depression and the 1987 rally came to an abrupt end with the 508-point loss on Black Monday, Oct. 19.

Greenspan received kudos for his handling of the 1987 episode, making sure the Fed supplied enough support to the banking system to keep the stock market plunge from spiraling into a financial panic. Treasury Secretary Robert Rubin said Sunday the government is prepared to take similar steps.

“Greenspan is aware that the boom in the stock market is fueling a lot of confidence and a lot of wealth,” said Lyle Gramley, a former Fed board member. “He will remind people that asset price inflation can be a source of economic instability.”

“Greenspan’s testimony will be of interest not because of his inflation forecast, because there isn’t any,” said Ray Worseck, chief economist at A.G. Edwards & Sons in St. Louis. “But we may smoke out whether he sees the current condition as a temporarily permanent one, or whether he’s still looking under rocks for snakes.”

There is a growing group of economists who think Greenspan should address the apparent disinflation.