Michael J Prell, a long-time central bank mandarin, spent the better part of the last 30 years arguing – politely, of course – the Fine points of the substance and presentation of Federal Reserve policy with the likes of Alan Greenspan, Paul Volcker and Arthur Burns. He retired in July at the age of 55 after heading the largest group of staff economists – numbering 120 – at the Fed in Washington.
| Prell: known for his spit and polish | ||||||
Prell’s salary actually had been higher than Greenspan’s for years.
His arrival at the Fed was not promising.
Prell’s trademark beard and a PhD from the University of California, Berkeley, spelled culture clash at the start of his career.
Banks in America’s Midwest weren’t exactly rolling out the welcome mat for fuzzy faces in those days. And the Kansas City Fed, where Prell began, wasn’t inclined to test the limits of anybody’s hospitality. The word went out, “Don’t let him leave the building”, instantly turning Prell into a true Fed insider in more ways than one.
Prell, who is a determined competitor with iron-willed self-control, eventually became known for his spit and polish. Those traits served him well when he moved to Washington in 1973 and began writing speeches for the crusty, imperious Fed chairman Arthur Burns.
It was the end of an era. America was having one last Fling with price controls, while both inflation and recession hit the economy hard.
The combination proved so difficult to swallow that it eventually moved Burns to write a book entitled The Agony of Central Banking.
It later fell to Paul Volcker to tame inflation. The Fed drove interest rates to “the highest levels since Jesus Christ”, as West German chancellor Helmut Schmidt put it.
The full force of automation, meanwhile, was sweeping through the numbers factory that was, and still is, the Fed.
Prell rose to become the influential director of the Fed’s research and statistics division by the end of Volcker’s term. And what great luck it was to begin serving in such a job just as that card-carrying number-cruncher, Alan Greenspan, was about to take the helm.
Greenspan would be an avid consumer of Prell’s labours for the next 13 years. And Prell was in a unique position to transmit his views to every board member via the Fed’s fabled “Green Book” that the staff prepares each time the Open Market Committee meets.
The Fed, of course, is far more than a production line for numbers. It’s part of the US government. Yet it’s an independent agency.
Great political skill is needed to keep it that way. So, how has the Fed been able to steer the US economy between inflation and recession without losing that independence?
Prell tells Euromoney that the Fed is under political pressure much of the time. But the Federal Reserve Act excludes the central bank from the same budget process that applies to other government agencies. And that helps. “A lot of pressure can be exerted via the purse,” he says. “But, in the end, I suspect that administrations and congresses have found it valuable to have someone else to blame or at least to share the blame when things aren’t going well. Moreover there’s ultimately a certain appreciation of having an independent central bank that can act with a perspective that’s longer than one election cycle.”
Fed people are sensitive to the fact that they have a lot of influence over people’s lives, even though they aren’t elected. So they feel a strong need to gain public acceptance for Fed policies and they reach out with information in ways that sometimes can seem, well, inscrutable and even strange.
One of the great virtuosos of all time, of course, has been none other than Alan Greenspan. “His conviction that the productivity growth was improving starting in the mid-1990s certainly put him out on a limb among the professional economists,” observes Prell. “But he was echoing what many businessmen had said for a long time about how they were totally revamping what they were doing.” Greenspan, in retrospect, identified this shift at about the right time and he factored it into his thinking about inflation risks, helping him move policy in a way that worked out reasonably well.
Prell points out that a number of things that are very important in shaping the course of the economy certainly turned out better than anyone, including Greenspan, expected. The view from the Fed was that inflationary pressures were mounting considerably. But the dollar came on strong for a few years. The Asian crisis undercut demand on a worldwide basis – clearly not a good thing in itself but a factor that relieved strains in US industry.
And the US stock market continued to levitate, sparing the US from a Financial shock despite doubts about the rationale for share prices.
Does the US stock market suffer from “irrational exuberance”? Absolutely, according to Prell. “There might be an inclination to say that chairman Greenspan was wrong four years ago about whether it [irrational exuberance] was a problem, in light of the subsequent market advance,” he says. “But the ability of shares to climb further does not establish that there were sound under-pinnings.” Prell thinks that people have developed unreasonable expectations of the returns that they can expect from a stock market portfolio based on the run we’ve had since 1982. “I just don’t think those expectations are consistent with an economy that is growing at plausible rates,” he warns. “People probably are not recognizing the potential variability in returns over periods that might prove relevant to them.”
It has been difficult for Greenspan to speak bluntly because so many people have become enamoured of the stock market and the fact that it has made them better off. But the returns from equities are an important factor in the US economy and remaining silent would prevent the public from understanding the Fed’s view on monetary policy. Some people have proposed that the Fed increase margin requirements but policymakers reacted quite negatively. For his part, Prell isn’t sure that it would put a damper on speculative investment but he wouldn’t have opposed trying it. For now, Greenspan has concluded that the Fed shouldn’t do anything that is tantamount to targeting stock prices.
Although the apparent absence of accelerating inflation has helped to maintain high levels of confidence on Wall Street and among consumers, analysts have begun asking whether these conditions are too good to be true.
Indeed, analysts have been suspicious for some time about the integrity of some of the most important components of the US consumer price index.
Two economists at the Federal Reserve Bank of New York, Jonathan McCarthy and Richard W Peach, have produced evidence that the CPI has been understating inflation in housing costs and the forecasting community is sceptical about the method used to estimate the cost of computer equipment. “I think there are many elements of the CPI that are open to question,” says Prell. “Technological change has probably exacerbated some of those problems, but I don’t see that any of the mysteries of the last few years would be resolved by inflation having been higher than officially reported. In fact, some might be better resolved by the opposite.”
Euromoney caught up with Prell on the day that the Bank of Japan decided to end its 18-month policy of zero overnight interest rates. And he weighed in squarely on the side of the sceptics. “There are very serious questions about whether this is a good time to take that action,” he said. “The economy still is struggling to recover solid momentum and I would have hesitated to support the change if I were on the policy-making board there.”
Some view the move, at least superficially, as a declaration of independence by the Bank of Japan. “So, one could say they showed a certain amount of backbone in pursuing the policy that they felt correct,” Prell observes. “But at least one simplistic view of the situation was that they put their heads on the line. If the economy suffers whether because of this action or for other reasons in the coming months, they’re an obvious target for blame.”
