Alan Greenspan, who six years ago branded share price values as "irrational exuberance", yesterday insisted the US Federal Reserve Board could have done nothing to avert a stock market bubble.
The chairman of the Fed said hikes in interest rates directed at deflating a share price bubble could simply trigger a wider economic slump.
Mr Greenspan has been accused of creating the conditions for the current US recession by failing to tackle the boom in asset prices.
But Mr Greenspan told a high-profile economic conference meeting in Jackson Hole, Wyoming yesterday: "No low-risk, low-cost, incremental monetary tightening exists that can reliably deflate a bubble."
The economy boomed during the decade and the business cycle of expansion and contraction became less volatile, leading investors to pour ever-increasing amounts of money into stocks in the belief that earnings would keep rising, he said.
But he told the symposium, which was sponsored by the Kansas City Federal Reserve, that the Fed could not be sure a bubble was developing because IT investment had raised the level of US productivity.
"It was far from obvious that bubbles, even if identified early, could be pre-empted short of the central bank inducing a substantial contraction in economic activity, the very outcome we would be seeking to avoid," he said.
Mr Greenspan used a speech in December 1996 to ask whether the Fed would know if "irrational exuberance" had taken hold of investors.
In July 1999 he warned Congress that productivity acceleration could not alone ensure stock prices were not too high.
Yesterday, Mr Greenspan said the Fed would have to change the mindset of investors to relieve an asset price bubble.
But he added: "Prolonged periods of expansion promote a greater rational willingness to take risks, a pattern very difficult to avert by a modest tightening of monetary policy."
He did not comment on current economic conditions other than to say that the recent recession was "relatively mild".
The Fed's open market committee meets on 24 September. At its meeting a fortnight ago, it said the risks were weighted towards contraction, which was seen as hint it could cut rates soon.
There was mixed evidence of the state of the economy from figures published yesterday. Manufacturing in the industrial Midwest rose for the seventh month in a row in August.
The pace of growth accelerated sharply, said the National Association of Purchasing Management in Chicago.
Government data showed personal spending surged 1.0 per cent in July, the biggest since last October, on the back of car sales.
But the confidence of the average American fell to its lowest level since November. The University of Michigan's final August consumer sentiment index fell slightly and disappointed forecasts for a rise.