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. Last Updated: 07/27/2016

Fed Tries to Soothe Investor Fears

WASHINGTON -- A day after Wall Street endured one of its most unnerving rides, Alan Greenspan, the Federal Reserve chairman, offered soothing words to investors, saying as explicitly as he ever has that the central bank's interest rate increases are not intended to drive down stock prices.

But as he has now for months, Greenspan continued Wednesday to identify the wealth being generated by rising stock prices as the primary cause of imbalances in the economy that could potentially lead to inflation.

Greenspan seemed intent on drawing a distinction between raising or lowering interest rates based on movements in the stock market - a strategy he said would be ineffective and perhaps inappropriate for the Fed to attempt - and acknowledging that Wall Street's effects on the rest of the economy are so powerful that they have to be taken into account in monetary policy.

The distinction was subtle if not meaningless to some analysts and investors. In their view, the Federal Reserve chairman wants to have it both ways, putting pressure on the markets without taking heat for it, and they suggested that Greenspan did not mind sowing a bit of uncertainty to keep the markets in check even as he reassures them.

"Each time he denies that he's targeting asset prices, he highlights the fact that equity prices are central to monetary policy at the moment," said Rory Robertson, an economist at Macquarie Bank in New York.

"Removing equity market strength is going to be part and parcel of removing economic imbalances, whether or not you say that you're targeting equity prices."

Speaking at a White House conference on technology and the economy, Greenspan was much clearer that he is sticking for now to his strategy of raising rates in small steps until he is sure that the economy is on an even keel. He said the Fed would not go "far wrong if we maintain a consistent, vigilant, noninflationary monetary policy."

Greenspan peppered his speech with admiring phrases about the ways in which information technology has reshaped the economy in recent years, calling current conditions "profoundly different" and "without precedent." And he said that the pickup over the last few years in the growth rate of productivity - potentially the most fundamentally beneficial change of this era in economic history - shows no signs yet of slowing down.

But he warned that the positive developments could be put at risk if the Fed allowed inflation to infect the economy.

The risk of that happening, he said, stemmed from the most basic of misalignments in the economy, between demand, which is rising sharply, and supply, which cannot keep pace.

In Greenspan's view, growth in demand is exceeding the corresponding increase in supply because it stems not from an increase in the nation's capacity to produce but from the wealth created by rising prices for stocks, homes and other assets, the gyrations of the last few weeks on Wall Street notwithstanding.

"The rise in stock prices, as well as in the capital gains on homes, has created a marked increase in purchasing power without providing an equivalent and immediate expansion in the supply of goods and services," Greenspan said.

Economists, analysts and investors have taken Greenspan to mean that the most direct way to bring supply and demand back into balance is to choke off the wealth effect. But Wednesday, Greenspan moved closer to the more traditional central bank position that the remedy is as simple and as complex as slowing the entire economy, halting the gradual drop in unemployment and arresting the growth in the trade deficit.

"The persuasive evidence that the wealth effect is contributing to the risk of imbalances in our economy, however, does not imply that the most straightforward way to restore balance in financial and product markets is for monetary policy to target asset price levels," Greenspan said.

"Leaving aside the deeper question of whether asset-price targeting is an appropriate government function," he continued, "there is little if any evidence that monetary policy aimed at achieving that goal would be successful."

He went on to stress that the focus of monetary policy should be the broader economy and any potential imbalances within it.

"Should changes in asset prices foster economic imbalances, as they appear to have done in recent years, it is the latter we need to address, not asset prices," he said.