JACKSON HOLE, Wyoming, 30 August 2003 — Fed Chairman Alan Greenspan said yesterday that monetary policy-makers need human judgment, not strict rules, to manage risks and sometimes take out “insurance” against dangers such as deflation. In a speech at a symposium sponsored by the Kansas City Federal Reserve, Greenspan offered no fresh views on the state of the US economy.
But he defended the Fed’s actions this year and responded to critics such as Fed Gov. Ben Bernanke who have argued against the Fed’s seat-of-the-pants policies in favor of specific inflation or growth targets such as those used by other central banks. Greenspan said that because economic models are based on incomplete information, it is better to use subjective judgments about the best policy.
It is “highly doubtful” that a formal policy rule would improve policy, he said. “Rules by their very nature are simple, and when significant and shifting uncertainties exist in an economic environment, they cannot substitute for risk-management paradigms, which are far better suited to policymaking.”
Greenspan said the Fed sometimes must take out “insurance” against some adverse outcomes such as deflation even if the probability is low. The comments appeared to explain the Fed’s actions to keep interest rates at near-historic lows while maintaining that deflation is unlikely.
The current economic circumstances “have inclined Federal Reserve policy-makers toward policies that limit the risk of deflation even though the baseline forecasts from most conventional models would not project such an event,” Greenspan said.
Similarly, the Fed acted to pump money into the economy after the 1998 Russian default, even though the US economy was not in trouble. “We eased policy because we were concerned about the low-probability risk that the default might severely disrupt domestic and international financial markets, with outsized adverse feedback to the performance of the US economy,” he said.
Confusion over the Fed’s policies led the bond market on a wild ride this year, with yields on the 10-year note falling as low as 3.07 percent before soaring to their current level of around 4.50 percent.