By Robert J. Samuelson
Saturday, September 3, 2005
JACKSON HOLE, Wyo. -- He is the dour optimist. Alan Greenspan, completing 18 years as chairman of the Federal Reserve Board and the world's most influential economic figure, flew here last week for a conference to celebrate and criticize his record. There wasn't much criticism.
Economists Alan Blinder (a former Fed vice chairman) and Ricardo Reis of Princeton concluded that Greenspan has a "legitimate claim to being the greatest central banker who ever lived." Economist Allan Meltzer of Carnegie Mellon University, author of an exhaustive history of the Fed, cited these figures: From 1987 -- when Greenspan arrived -- to 2004, the U.S. economy added 27 million jobs and raised per capita consumption by 44 percent. Over this period there were two brief recessions, those of 1990-91 and 2001, lasting a total of 16 months. The Fed has had 12 chairmen since its creation in 1913; Greenspan "stands in the front rank," said Meltzer.
Considering Greenspan's present canonization, it's worth recalling that after his nomination by President Ronald Reagan, some critics ridiculed him as a right-wing nut and "gold bug." Well, that's an apt commentary on the reliability of partisan political stereotypes. Greenspan actually had closer relations with the Democratic Clinton administration than with either Republican Bush White House. At the conference, organized by the Federal Reserve Bank of Kansas City, Robert Rubin, one of Clinton's Treasury secretaries, lavishly praised Greenspan's "graciousness" and open-mindedness.
Of course, Greenspan didn't single-handedly expand the economy. He regards the free enterprise system -- its reliance on risk-taking, private markets and individual exertion -- as the bedrock of American prosperity. This faith feeds his optimism. And there is a second sense in which Greenspan has also disclaimed credit for good economic performance. From 1979 to 1987, inflation dropped from 13.3 percent to 4.4 percent -- the work mainly of Greenspan's predecessor, Paul Volcker, backed by Reagan. Because high inflation is wildly destabilizing (four recessions from 1969 to 1982), this decline automatically fostered improvement.
Still, there were ample opportunities for deeper, longer slumps.
Consider: Just after Greenspan's appointment, the stock market plunged 20 percent in one day. During the 1990-91 recession, the U.S. banking industry suffered more than at any time since the Great Depression; from 1989 to 1992, about 500 banks went out of business, recalls economist David Hale of Hale Advisers. The 1997-98 Asian financial crisis was arguably the worst threat to the global economy since World War II. One side effect -- the near bankruptcy of hedge fund Long-Term Capital Management -- caused many frightened bond buyers to stop investing. And then there was the "popping" of the stock market bubble in 2000; shareholders lost $8 trillion in paper wealth.
Challenges came "in a variety of shapes and sizes," said Blinder and Reis. "The right answers were not to be found in any pre-existing monetary manual." Yet, no potential calamity became an actual calamity -- and for this Greenspan deserves much credit.
His style is paradoxical. He rigidly embraces some principles and otherwise is hugely flexible. One principle is the significance of price stability: a condition he defines as keeping inflation so low (generally 1 percent to 2 percent) that it doesn't affect consumer and business decision-making. Price stability matters because (again) high inflation leads to stop-go cycles that weaken employment, growth and confidence. Despite the present surge in oil prices, which is not a generalized inflation, Greenspan virtually achieved his goal. From 1995 to 2004, inflation averaged 2.4 percent.
A second principle is the inevitability of ignorance. The economy is so complex and changes so rapidly that no economic model -- "no matter how detailed or how well conceived," he told the conference -- can ever capture reality. This explains Greenspan's dourness: the certainty of uncertainty. Although private markets often quietly self-correct, they're also prone to large miscalculations and unpleasant surprises. One reason Greenspan is an avid economic detective, devouring statistics and anecdotes, is that he's trying to limit uncertainty by discovering new economic patterns.
Given his principles, Greenspan is wedded to neither easy nor tight money. To preempt higher inflation, the Fed raised interest rates sharply in 1994. But after spotting an improvement in productivity in late 1995, he advocated lower rates even when other members of the Fed wanted them raised. (Note: higher productivity, aka efficiency, helps businesses dampen price increases.) When bond markets quivered after the Long-Term Capital Management episode, he temporarily lowered rates. The antidote to the burst stock bubble was the same; overnight rates dropped to 1 percent in June 2003.
Greenspan calls his approach "risk management." The Fed should identify the economy's greatest vulnerabilities and try to counteract them. This is much harder than it sounds, because incomplete and conflicting information often obscures those vulnerabilities. Judgments are required, and Greenspan's have been remarkably good. Still, many risks remain: oil prices; the housing boom; the huge U.S. overseas trade deficits; the budget pressures of an aging society; Americans' shrunken personal savings rate; rapid changes in the global economy.
The trouble is that the Fed's powers are modest. It sets only the overnight fed funds interest rate, which indirectly influences other rates on bonds and mortgages and, through them, the broader economy. There are conflicts among goals; the Fed's low interest rates have helped the economy -- and inflated home prices. But Greenspan has generally made the most of the limited tools and, by doing so, has inspired a broader confidence. His term ends next January, and his success leaves an ironic legacy: the illusion that the Fed has more control than it actually has.