ALAN GREENSPAN'S CRYSTAL BALL

By Adam Zagorin

ALAN GREENSPAN'S OFFICIAL TITLE IS Chairman of the U.S. Federal Reserve. But he functions as something akin to America's economic Prognosticator in Chief. For decades Greenspan, 78, has constantly kept a finger in the air, trying to divine the economic future and determine how best to prepare. Is the economy poised to heat up? Raise interest rates. Is it likely to cool down? Cut them a quarter-point. During his tenure, a period that has stretched over four Presidents and assorted stock-market rises and falls, Greenspan has commanded dozens of interest-rate adjustments. For tens of millions of Americans--investors, traders, homeowners--fortunes big and small have been made or lost depending on his judgments about the future.

Despite the importance of Greenspan's task, he is cagey about his methods. He routinely declines press interviews and will describe his decision-making processes only via circumlocutions that even some veteran Fed watchers find confusing. He relies, of course, on factory reports, unemployment stats and other economic data. But he has also developed his own method to help evaluate the likelihood of various scenarios, assigning a probability to each outcome. His priority, he told the Senate banking committee in June, is understanding "the many sources of risk ... quantifying [them] ... and assessing the costs associated with each."

In his role as protector of America's economic future, Greenspan sometimes acts to head off scenarios that are exceedingly remote but, in the worst case, could do extreme damage. Concerned last year that growth was not taking hold despite large tax cuts and worried over the slim possibility that the economy could slip into a deflationary spiral, he opted to cut short-term interest rates to 1%, their lowest level since 1958. "His policy was to move aggressively to pre-empt the chance that this small-probability event would ever take place," says Roger Ferguson, the Fed's vice chairman. "The reward was to avoid any likelihood of deflation or economic collapse, but with a risk the Fed could end up stimulating inflation." It worked out: inflation remained in check.

Greenspan, a former jazz musician (he played clarinet and sax) and a disciple of free-market philosopher Ayn Rand, frequently confronts such agonizing choices. As the Clinton era drew to a close, he correctly foresaw the brewing bubble in high-tech stocks. He searched for a way to alert investors, famously referring to an "irrational exuberance" building up in the stock market. But he refused to say more, believing a sudden collapse in share prices would carry more risk than allowing the market to discover the bubble itself. The high-tech balloon continued to inflate for several years after his warning, then collapsed rapidly, proving the Fed Chairman's prescience.

Over the years, Greenspan has shown a knack for forecasts that have pleased Wall Street and Main Street alike. In mid-September he raised short-term rates one-quarter of a percentage point amid mixed signals on the economy. Growth is relatively robust, despite high energy prices, fears of a housing bubble and spots of stubborn unemployment. This time Greenspan was betting not just that the good news would prevail but also that America might soon confront the risk of renewed inflation. Greenspan is fond of noting that his job involves the study of how human beings react to a continually changing economy. "If we judge that current conditions are similar to particular historic circumstances," he says, "then we can expect a similar result and, with some range of error, anticipate the future." And in Greenspan's case, perhaps even control it. --By Adam Zagorin