O'Sullivan: Get a grip, Don, and follow the biggies

Alan Greenspan's rear-view mirror approach to driving monetary policy is now being labelled "really not the smartest way to pilot the world's largest economy."

The Fed chief may be applying the defibrillator with quick-pace interest-rate cuts to the US economy. But he nearly killed the patient in the first place by putting up rates too high - or so critics claim.

It is a situation which has strong parallels in New Zealand, where Reserve Bank Governor Don Brash's steerage of monetary policy is being scrutinised after he failed to pick the huge slowdown in the US economy.

The market read his December 6 monetary policy statement as tipping more interest rate hikes early this year.

But the hawk rapidly turned dove and took a neutral stance after Greenspan began rapidly easing the US economy in January.

The trouble is, no-one has a clear view on whether Brash will increase interest rates at the next official cash rate review, in March, leave them the same or cut them.

That Greenspan hardly got his own calculations right will not come into the equation. What is at issue is the basis on which central banks form their monetary policy decisions and their frequent reliance on lagging economic indicators.

Monetary policy is an inexact art at the best of times. As Brash, quoting the Economist, notes, it is like "driving with a blacked-out windscreen, a wonky speedometer and a cracked rear-view mirror."

But New Zealand business would rather Brash belted himself firmly into the driving seat, made sure he had both his hands on the steering wheel and cleaned the fog off the front, side and rearview mirrors - or stayed out of the car altogether.

In the Fed chief's case, he is still probably the most powerful man in the world - but the gloss has gone off his reputation.

Greenspan's critics claim his excessive anti-inflationary zeal and desire to take the steam out of the stock market bubble - which led him to raise the cost of borrowing money by 175 basis points in six price gouges - is what really choked the US economy.

It wasn't, they say, other factors such as the US economy's large current account deficit, high personal debt levels, zero savings rate and an overvalued high-tech stock sector.

But the Fed chairman is at least trying to pilot the US economy away from the shoals, on to which he has arguably steered it.

It is hard to fathom why New Zealand is not also taking a nimble-footed response to the US downturn and cutting interest rates.

For the first time since the early '90s, investors in US companies are facing an earnings recession. The profit warnings that have dominated headlines for the last month are now being matched by job loss announcements and the fortunes of Standard & Poor's 500 companies will be down for the next two quarters.

Britain and Europe may be basically economically healthy. But they are taking out insurance policies against the impact of the weaker US economy on global growth. The Bank of England has trimmed its rates from 6 per cent to 5.75 per cent - its first rate cut since June 1999. The European Central Bank is expected to trim rates in March or June.

Investment intentions are also switching from the US to Europe.

European economies are expected to grow by an average 2.5 per cent to 3 per cent in 2001. Tax cuts will also boost demand over the Euro Zone.

This changed focus is not surprising when the US economy grew by only 1.4 per cent annualised in the December quarter, its worst quarterly performance in more than five years.

US Labour Department reports show initial applications for benefits for jobless were up 15,000 to 361,000 for the week beginning February 3. The nation's unemployment rate jumped to 4.2 per cent in January, the highest in 16 months after the impact of the loss of 65,000 manufacturing jobs filtered through.

But Greenspan has one great advantage in the economic war. Enter Dubya.

George Bush's $US1.6 billion ($3.66 billion) tax cut jumpstart to the US economy may not get into gear until 2002.

Let us leave aside today the interesting truth that the President and his wife will get windfall gains 20 to 60 times larger than anyone earning under $US50,000 - a factor the Democrats will mine as the tax bill makes its way through Congress.

On current projections the US Federal Government will take in $US5.6 trillion more than it will spend in the next 10 years. Nearly $US2.5 trillion is tagged for social security but Bush still has $US3.1 trillion to play with.

Bush's tax cut announcements produced concerns that the US budget surplus could be squandered. But the surplus forecast has risen by $US1 trillion in six months.

Even Greenspan, who has consistently argued that federal surpluses should be applied to debt reduction rather than tax cuts, has seen the benefits of a philosophical change of stance as the US economy verges on recession.

In his words, excessive budget surpluses are undesirable because "just like excessive deficits, excessive surpluses distort the structure of private economic growth, and that's bad."

The US economy may be out of the mire by the third quarter of this year - but when stronger economies such as Britain and the European countries are taking out insurance policies by dropping interest rates now, it seems imprudent for New Zealand not to follow suit.