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Exit the Maestro
Will Greenspan's Legacy Become Bernanke's Burden?

By Robert J. Samuelson
Wednesday, February 1, 2006

No man's reputation is safe at his retirement, and so it is with Alan Greenspan's. History's verdict will await subsequent events that reveal the long-term consequences of his 18 years as chairman of the Federal Reserve. But until then it's silly to discount (as the Economist recently did) his apparent accomplishments. Doubters should consult standard economic statistics covering his tenure since 1987:

· The U.S. economy (gross domestic product) has expanded 72 percent, and its growth rate has outstripped that of virtually every other advanced country.

· The number of payroll jobs increased by 32.1 million (31 percent) from August 1987 (Greenspan's first month) to December 2005.

· There have been only two brief recessions, those of 1990-91 and 2001, lasting a total of 16 months.

· Business productivity has risen about 50 percent since 1987.

· Interest rates dropped from 8.39 percent on 10-year Treasury bonds and 9.31 percent on 30-year mortgages (1987 averages) to 4.5 percent and 6.1 percent, respectively.

· The Dow Jones industrial average quadrupled, from 2,680 on Greenspan's first day (Aug. 11) to 10,900 (as of Jan. 30).

The tricky question is how much credit Greenspan deserves. Not all, of course. The U.S. economy's vibrancy and flexibility (a favorite Greenspan word) explain much. But some credit, for sure. Two months into Greenspan's tenure, the Dow plunged 22.6 percent on a single day (Oct. 19). By lowering interest rates, the Fed helped avert a crisis of confidence. Something similar happened in the 1997-98 Asian financial crisis. Easier money helped sustain the U.S. expansion -- and prevent a global slump. So goes the standard accounting of Greenspan's stewardship.

It's deficient. What it omits is disinflation , the decline of inflation from 13.3 percent in 1979 to today's low levels. Disinflation has been a transforming, if underappreciated, economic event. Among other things, it partially explains: the bull market of 1982-2000 (in August 1982 the Dow was as low as 777); the U.S. consumption boom (since 1982 the personal savings rate has fallen from 11 percent of disposable income to zero); huge trade deficits; and the recent housing boom.

Lower inflation meant lower interest rates. Lenders and investors required less to offset the eroding value of their money. With lower rates, investors switched money to stocks from bank certificates of deposit, Treasury securities and money-market funds. Stock prices rose. As they did, people felt wealthier and spent more of their income -- or borrowed more. Lower inflation and surging stocks restored overseas confidence in the dollar. To invest here, foreigners bought more dollars. The dollar's exchange rate rose, making U.S. exports less competitive and U.S. imports cheaper. Trade deficits ballooned. The housing boom has been a later disinflation effect because home-mortgage rates fell steeply from 2000 to 2005.

Granted, this thumbnail history oversimplifies. It excludes critical events, trends and caveats. Yes, speculation in tech stocks propelled the market in the late 1990s. Still, the history captures the broad contours of Greenspan's tenure. But disinflation was not a spontaneous event. It resulted mostly from the Fed's policies, first under Paul Volcker and then Greenspan. It is their largest triumph, even if Greenspan had help from new information technologies (aiding firms in cutting costs), greater globalization (keeping prices down) and intensifying competition (doing the same).

The Economist and others criticize Greenspan for holding short-term interest rates too low and, thereby, feeding the late-'90s "stock bubble" and now a "housing bubble." What these criticisms miss is that the stock and housing markets respond mainly to long-term interest rates (on bonds and mortgages). In turn, these long-term rates reflect inflationary expectations and other factors that, frankly, aren't well understood. The Fed directly sets only the overnight Fed funds rate. Greenspan himself has expressed surprise that long-term rates have stayed so low, especially since the Fed has raised the Fed funds rate to 4.5 percent from 1 percent in mid-2004.

None of this secures his reputation. Although disinflation has delivered huge benefits, it has also left those big potential problems: heavily indebted consumers, a possible housing "bubble" and massive trade deficits. These problems may work themselves out, as Greenspan and his successor, ex-Princeton economist Ben Bernanke, hope. But they put a premium on Bernanke's early performance.

On the one hand, he has to establish his anti-inflation "credibility." If he doesn't, confidence could suffer. Investors might sell bonds, sending long-term interest rates up. Traders could dump dollars, sending the dollar's exchange rate down. There would be ripple effects on the stock market, consumer spending and housing. Some economists think Bernanke will have to raise the Fed funds rate more than Greenspan just because he's new. On the other hand, if he raises rates too much, he might trigger a recession. Greenspan's successor is in a delicate spot, and how well Bernanke does will affect both their reputations.

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