Greenspan's Big Test

If any one man can decide how last week's market turmoil will affect the U.S. economy, and indeed that of the entire world, he is Alan Greenspan, 61. As chairman of the Federal Reserve Board, the soft-spoken economic forecaster is the ultimate arbiter of the nation's credit supply and thus of the interest rates at which money is lent throughout the U.S. banking system. On the job less than three months, Greenspan is suddenly being forced to make rapid and delicate decisions to prevent the market crash from turning into a mushrooming financial collapse and to stave off a steep recession. Says Charles Schultze, who was chairman of President Jimmy Carter's Council of Economic Advisers: "Greenspan is in a very difficult period in which he is truly being tested."

Following Black Monday, Greenspan moved quickly to avert further disaster. The day after the market's plunge, the new Fed chairman cut short a speaking trip to Dallas and hurried back to his ornate second-floor office in Washington's Eccles Building. He had already issued a terse announcement that the nation's central bank would "serve as a source of liquidity to support the economic and financial system." That was a signal that banks would have no difficulty obtaining additional credit as needed to provide for the huge losses sustained by shell-shocked brokerages. Greenspan's announcement produced an immediate decline in interest rates, as the banking system moved in effect to replace some of the $500 billion in stock values that vanished on Black Monday.

Greenspan also began moving behind the scenes to bolster the Reagan Administration's political response to the crash. Within an hour of Treasury Secretary James Baker's return from West Germany to Washington on Tuesday, Greenspan was huddling with him to plan the Administration's response to the market crash. Later that day the Fed chairman helped persuade Reagan to offer Congress a summit meeting to negotiate a federal-deficit reduction program.

People like Lyle Gramley, a former Federal Reserve governor who is now chief economist for the Mortgage Bankers Association, praised the Fed chairman for his decisive actions. But critics like Paul Craig Roberts of Washington's Center for Strategic and International Studies charge that Greenspan also helped cause last week's market disaster. They note that back on Sept. 4, Greenspan's first important move as Fed chief was to push successfully for a hike in the bellwether discount rate, the interest that the Fed charges on funds lent to financial institutions, from 5 1/2% to 6%. It was the first such increase in nearly 3 1/2 years.

Greenspan justified the rate hike as a move against potential inflationary pressures, which indeed it was. But for investors, any increase in interest rates makes stocks less attractive, since higher returns become available for bonds, Treasury bills and other fixed-income securities. During the two trading days after the Fed announced its decision, the Dow Jones industrial average dropped 54 points. Admits Gramley: "A common problem is the markets do not understand Alan Greenspan's statements. He needed to express ((the Fed's decision)) more clearly."

Greenspan's task is especially difficult because he follows Paul Volcker, who left the Fed last August after eight years as chairman. Volcker was legendary for his ability to inspire confidence at home and abroad. Greenspan's experience is also grounds for reassurance. In 2 1/2 years as Gerald Ford's chief economic adviser, he had some success in combatting inflation, then the nation's main economic woe. But, unfortunately, the progress was temporary, and inflation was not decisively licked until a severe credit squeeze was imposed in the early 1980s by Volcker and the Fed.