Greenspan Legacy: A Dragon Throttled

Was your inflation rate 2% last year?

Tallying up your gasoline and grocery bills, you may feel like 2% is a low-ball figure for inflation.

But that number seems legitimate to much of Wall Street because it is the inflation rate as measured by the preferred price gauge of Federal Reserve Chairman Alan Greenspan.

As the central bank chief prepares to step down this week after 18 years at the helm, his legacy is that he subdued the inflation dragon once and for all.

Indeed, he has convinced many big investors that there is virtually no chance of the dragon reviving.

That, some say, best explains the so-called conundrum: why long-term interest rates have remained so low even as the Fed has methodically raised short-term rates since mid-2004.

By this view of the world, the current 4.5% annualized yield on a 10-year U.S. Treasury note is a great return, one you should be happy to lock in, because there's little risk of rising inflation that would eat away at it.

If that's true, 30-year mortgage rates may be stuck around 6% for a long time to come. They might even fall toward 5% in the next few years, which could bail out tens of thousands of people who bought homes with adjustable-rate loans that are ticking time bombs.

As for the stock market, it could be thrilled if long-term interest rates stay where they are or edge lower. It already seems thrilled enough: The broadest measure of share prices on the New York Stock Exchange hit a record high Friday.

There are other possible scenarios for inflation and long-term rates, however. One is that they're poised to accelerate, not to the legendary levels of the 1970s but high enough to make fools out of many investors and economists, and to soil Greenspan's image -- not to mention leaving a mess for his successor, Ben S. Bernanke, who will take over the Fed chairmanship Wednesday.

When Greenspan succeeded Paul Volcker in 1987, memories of the double-digit inflation of the late 1970s still were fresh. Financial markets, which were crippled by rising inflation in the '70s, lived in mortal fear of another go-round.

Here's how Greenspan naturally would prefer the history books to read: It was his willingness to tighten credit by raising short-term interest rates in the late 1980s, in 1994, in 1999 to 2000 and for the last 18 months that quashed potential inflation pressures by slowing the economy, even to the point of recession in 1990 and 2001.