How the Fed took Monty Python to heart

ALAN Greenspan has announced that infectious greed is the cause of today's corporate woes. In 1996, the chairman of the Federal Reserve told us we were suffering from irrational exuberance. He has been right twice. Unfortunately, he does not seem to heed his own words.

Investors who sold in 1996 and put their money into cash are today richer than those who held on to shares. Those who held bonds are much richer. The stock market's bubble and subsequent crash is Greenspan's monument. It shows how good his judgment was six years ago and how bad it has been since.

The infectious greed that he abhors today was encouraged by him. He did not just fail to repeat his 1996 warning, but turned from bubble critic to cheerleader.

Today, we run a big risk. Crashes are the usual consequence of bubbles, and recessions are the usual result of crashes. A wise Fed would be taking strong action today to delay the next US recession. Action may not be necessary but the risk is clear and action must be wise.

The Fed, however, appears to be confused rather than worried and the degree of confusion is deeply worrying. This can be seen, with startling clarity, in the Press release that followed its most recent interest rate policy-setting open market committee meeting on 26 June.

According to this remarkable document, the committee had noticed that demand had recently been disappointing but expected 'demand to pick up over coming quarters, supported in part by robust underlying growth in productivity'. If this were written in a first-year exam paper, the author would be lucky to be allowed back into college for his next term.

Even the most kind-hearted examiner would be critical of the confusion between demand and supply. There is plenty of spare capacity in America today. So rising demand poses no inflationary threat, even if productivity is poor. It follows that productivity is simply not the issue. The better it is, the greater the potential supply. But the cause for concern is not supply, it is demand. A central bank that does not know the difference is a cause for worry. If it is the Fed, the world's major central bank, then it is a matter of world concern.

We are back to the famous parrot who wanted to learn English. As it seemed a rather difficult language, the bird decided to become an economist. This way, it thought, it would only have to learn two words - supply and demand.

With the example of the Fed before us, we can be most supportive of Polly. If she understood the difference between supply and demand, she was clearly ahead of the field. Perhaps the bird writing the Fed's releases is one of Monty Python's Norwegian Blues - a notoriously dead parrot.

The concern is not really that the Fed cannot tell potential supply from demand. The worry is that it is obsessed with productivity and is desperate to believe it will somehow cause its mistakes to be overlooked.