Greenspan's dilemma

WASHINGTON
IT HAS been a year of mixed results, mostly bad ones for ordinary Americans.

So when the Federal Reserve raised its benchmark short-term interest rate for the ninth straight time late last week, long-term interest rates went in the opposite direction -- again. The government's key rate, on 10-year Treasury bonds, is a tad below 4 percent, less than three-quarters of a point above the overnight bank loan rate the Federal Reserve had just increased.

This unusual phenomenon has been occurring straight through the nine increases in the so-called federal funds rate, which raised it from 1 to 3.25 percent, where it hasn't been since the summer of 2001 when the Fed began cutting it like crazy to help stave off a recession after the bursting of the famous bubble in technology stock prices.

It has been more than four months since chairman Alan Greenspan called the unusual narrowing of the spread between short and long-term rates a ''conundrum." He's correct that a narrow spread is no harbinger of recession, but many experts suspect he wasn't correct when he suggested this might be a brief aberration. If the trend continues and the Fed keeps raising short-term rates to help keep inflation at bay, the long rates might actually fall below short ones by the end of the year, and that ''inverted curve" has an excellent track record of recession prediction.

For now, it appears that the Greenspan Fed is intent on maintaining its year-old course. In the closely watched statement issued after its regular meeting, the central bank's open market committee said that while inflationary expectations in the marketplace are quite calm, ''pressures on inflation have stayed elevated."

The big question involves long-term rates. Often, falling long-term rates are great news. When they came down in the early 1990s as the federal government began to get its deficit-plagued house in order, the decline was a harbinger and partial cause of the historic economic expansion that ensued.

Today, however, the situation is much more mixed. The good news is that low rates still stimulate the economy, especially by making housing production attractive and by spurring productive investment generally. They are also a sign that expectations of future inflation are contained, permitting lower ''premiums" to guard against it, despite soaring costs of basics like energy and healthcare.

The problem is that low long-term interest rates are also a clue to a weakening economy with less demand for credit. And these low long-term interest rates have also fueled an explosion in real estate speculation. Greenspan has called the frantic activity ''froth." It is not only the kind of bubble that eventually bursts, it is itself feeding inflation that the Federal Reserve will work to contain, even if the economy slows as a result.

Many experts tell a narrative story of this decade as a tale of two bubbles, first in high-tech and now in housing, fueled by the Federal Reserve, unheard of budget deficits, and mounting public and private debt.

This unprecedented amount of monetary and fiscal stimulus was enough to keep the economy from experiencing more than a very brief dip after the 9/11 attacks. However, the growth that followed has been historically anemic, with unusually spotty and limited job growth and enormous pressures on households with modest incomes. The employment gains have not been enough to keep pace with Americans coming of working age, and the squeeze on families of average income and below has been brutal, in contrast to life at the tax-reduced top.

At this relatively mature stage of the business cycle, with economic growth beginning to slow, the stimulus arrows in the government's quiver are few, and the Federal Reserve is more likely than not to keep tightening monetary policy rather than loosening it. There are also indications that households are nearing the limit of their ability to refinance housing debt or take out home equity loans to meeting current expenses; households now owe a record 90 percent of the economy's annual output, a figure that has jumped by 20 points in the last five years.

Moreover, the rising indebtedness of Americans and of their government and business sectors is becoming a source of concern abroad because so much of the increased debt has been used to purchase goods and increasingly services from abroad. This year, the country's so-called current account deficit -- the gap in trade and financial flows with the rest of the world -- is in the area of 7 percent of domestic output, virtually unheard of for a developed country.

The lasting answer would be a return to fiscal sanity, but the odds of that in the near term are nil. The Federal Reserve can still help at the margins, but the fundamental forces loose in this country are worrisome.

Thomas Oliphant's e-mail address is oliphant@globe.com.