JACKSON HOLE, Wyo., Aug 29 - Federal Reserve Chairman Alan Greenspan on Friday said he preferred to set economic policy by managing possible risks rather than obeying formal rules. "Some critics have argued that such an approach to policy is too undisciplined -- judgmental, seemingly discretionary and difficult to explain," Greenspan said in a speech to the Kansas City Federal Reserve's exclusive annual conference. Some critics, including Fed Governor Ben Bernanke, have said the Fed should act according to formal policy prescriptions such as inflation targets, which many central banks use to keep prices within set boundaries.
"That any approach along these lines would lead to an improvement in economic performance, however, is highly doubtful," Greenspan said. He said the U.S. central bank's technique of considering future risks to its economic outlook shaped its response this year to the threat of a broad fall in consumer prices, or deflation, which forecasts regarded as remote. This spring, several senior Fed officials gave speeches outlining alternative policy tools the U.S. central bank could use to combat deflation if it ran out of interest-rate ammunition. This convinced financial markets that the Fed was considering such actions as buying bonds, prompting a plunge in long-term interest rates.
However, the Fed later made clear that such options were unlikely to be used, triggering a sharp reversal in the bond market and pushing up borrowing costs in such areas as home mortgages. Greenspan said on Friday that the desire to deal with risks preemptively "have inclined Federal Reserve policy-makers toward policies that limit the risk of deflation even though the baseline forecasts from most conventional models would not project such an event." The Fed chief used the same forum last year to give a lengthy defense of his handling of the 1990s stock market bubble and subsequent bust, which did little to allay criticism of the Fed's handling. //