THERE IS a peculiar paradox about Alan Greenspan. No public official in Washington is more revered than the Federal Reserve chairman, who has presided over eight years of economic expansion. And yet, in one important respect at least, he seems oddly marginal. He has long suspected that the stock market may be overvalued; and yet he can do nothing about it. In fact, his exalted reputation may make the problem worse.
Yesterday Mr. Greenspan pushed short-term interest rates up by a quarter of a percentage point, the second such move of the summer. According to the textbooks, higher interest rates mean a lower stock market, partly because they reduce corporate profits and partly because they suck investors' money out of equities and into bonds. In this instance, however, the textbooks were upended. Anticipating the rate hike, the Dow Jones Industrial Average jumped 199 points on Monday, and yesterday it held on to nearly all of that gain.
Nobody really knows why markets jump. But one theory is that Wall Street sees a rate rise as a reassuring sign that Mr. Greenspan is on top of things, so it is okay to party on. Of course, if the Fed had left interest rates stable, Wall Street would have partied on anyway, believing that Mr. Greenspan had scoured the horizon for inflation and seen none. In short, Wall Street is so confident in the Fed chairman that it appears to think nothing can go wrong under his leadership. Even a blatant effort by Mr. Greenspan to talk down stock prices, as when he spoke of the market's "irrational exuberance" three years ago, has no impact on investors' optimism.
This leaves Mr. Greenspan in an uncomfortable position. He can trust that yesterday's interest rate move will head off gentle inflation in consumer prices. But he cannot hope that it will dent the rampant inflation in stock prices. The higher Wall Street goes, the likelier it is that the eventual correction will be nasty, hurting investors enough to cause a sharp drop in consumption and hence an end to growth. It is a cruel irony that Mr. Greenspan's reputation may be contributing to the bubble, since that same bubble threatens the prosperity on which his reputation has been built.