IN THE 2000 US presidential election campaign, the candidates for the Republican nomination were asked in one of their countless televised debates what they thought about Alan Greenspan, whose term as Chairman of the Federal Reserve would some day expire.
Most of them, George W. Bush included, mumbled something polite about the Fed Chairman, whose status as saviour of the US economy seemed secure at that stage. But it was characteristically John McCain, the senator from Arizona, who had the last, immortal word.
“I would not only reappoint him as Fed Chairman,” he said, “but if by any bad chance he should die while in office I think I’d do what they did in the movie Weekend at Bernie’s — put a pair of dark glasses on him, prop him up and carry on as if nothing had happened.”
The post-Greenspan world that Mr McCain jokingly feared begins next week when the Chairman retires after almost 19 years at the helm of the world’s most powerful central bank.
The cinematic analogy was surely an appropriate one. The owlish, 78-year-old master of the polysyllabic circumlocution achieved a status akin to that of a Hollywood star. For a while his reputation was so unapproachable that politicians could not only joke about his continuing to serve posthumously, but they were desperate to be seen alongside him and craved his blessing for their own economic proposals.
His legacy, however, is more controversial. In the past few years, as the US economy has soured, many more economists and public figures have become Greenspan-sceptics, questioning both his decisions in the past ten years and his methods. Are they right?
The true believers in Greenspan as monetary policy god start with a relatively simple set of facts. In the past 19 years the US has enjoyed a period of unparalleled prosperity and economic stability. In the 222 months of Mr Greenspan’s tenure, the US has been in recession for only 16 months — that’s an average of one month of recession for every 14 — a much lower ratio of slump to growth than was the case in the previous 50 years.
Of course no one attributes all that to Mr Greenspan. Productivity improvements at US companies, freer markets and global economic integration have all helped to reduce US economic volatility. But his supporters say that, at critical moments, the Greenspan Fed took decisions that helped to maintain the non-inflationary growth when it otherwise might have cracked. Specifically, Mr Greenspan gained his reputation during a crucial period in the 1990s.
In 1994, as the US economy was picking up speed after the recession of 1991, the Fed raised interest rates sharply to head off inflation. More impressive, though, and more surprising, was what came next. Beginning in 1997, the growth rate began to accelerate well above what had been traditionally regarded as the sustainable, non-inflationary rate of about 2.5 per cent per year. As growth soared to an annual rate of more than 4 per cent, unemployment fell to its lowest level in more than 30 years.
This kind of rapid, employment-intensive growth had long been regarded by most economists as an inevitable precursor to inflation, and the Fed was urged to raise interest rates again. But Mr Greenspan had been closely following detailed company statistics that seemed to suggest that the US economy might be able to grow faster than previously believed.
These improved profitability figures were not initially reflected in the official productivity data but the Fed Chairman was convinced that there had been a step change in US productive potential, and he persuaded his colleagues at the Fed to hold off from raising interest rates. It seemed to work. From 1997 to 2000, the economy continued to grow rapidly while inflation actually fell. But the critics argue that what happened next proved them right and the Fed Chairman wrong after all.
This was the period of the “bubble economy” when stock prices soared on the back of wild optimism about the new economy. Though Mr Greenspan himself gave warning of the dangers of “irrational exuberance” in stock markets in 1996, he did not raise interest rates to rein it in. Critics say he should have been more aggressive. The reckoning came in 2000 with the collapse of the stock market. Could the Fed have prevented the bubble from inflating and avoided the problems from which the US is still suffering? We will never know, but Mr Greenspan’s defence is persuasive. To prick the asset bubble would have required aggressive rate increases. They might well have produced equity price declines but only at the expense of flattening the broader economy.
But critics also say the US is still suffering from the Greenspan errors. The collapse of the equity market helped to produce the recession of 2001. As the economy faltered, the Fed was forced to cut rates more aggressively than it had ever done before — the fed funds rate fell by 475 basis points in 18 months, to just 1 per cent.
Greenspan-backers say this again showed the Fed Chairman’s extraordinary flexibility when the economy needed it. But the critics contend that, in acting to offset the results of the collapsing equity bubble, Mr Greenspan inflated another bubble — this time in housing. In the next four years house prices took off towards what may be unsustainable levels.
But this critique doesn’t stand up to much scrutiny either. As one senior Fed official puts it: “What were we supposed to do? Just sit back and leave rates alone and let the economy go into a deep hole?”
The Greenspan genius lay in a flexible approach that enabled him to react to changes, ignoring if necessary hard and fast rules for monetary policy. That approach is unfashionable now and may actually disappear with the outgoing Fed Chairman.
Many economists — including Ben Bernanke, the new man at the Fed — prefer the more formally targeted approach to monetary policy, such as the Bank of England’s, with policy bent towards achieving a clear goal for inflation. But it is not clear that that would have produced a better result in the past ten years.
“The Greenspan era may stand as a pinnacle of a discretion-based approach, rather than rules-based approach,” said Benjamin Friedman, Professor of Economics at Harvard, at a seminar this month on the Greenspan era. “It was an outstanding era. Perhaps some day we may all come to admire it.”
The Fed Chairman got some things wrong. He probably became too much of a public figure, too enmeshed in politics, too willing to talk about matters beyond monetary policy. His support for the Bush Administration tax cuts in January 2001, on the ground that they were “necessary” to avoid the Government accumulating too much of a surplus, do not look good in the light of recent history.
Noting this, Greg Mankiw, former chairman of President Bush’s council of economic advisers, offered unsolicited advice to Mr Bernanke recently: “Become as boring a public figure as possible.”
As a policymaker Mr Greenspan certainly wasn’t perfect. But he is perhaps best seen as part two of a magnificent two-part act that controlled US monetary policy for the past 25 years. The conquest of inflation has been probably the single greatest economic achievement of the past 50 years. Paul Volcker, the Fed Chairman before him, took tougher decisions that were necessary to destroy the inflationary cancer that once threatened to destroy capitalism.
But Mr Greenspan completed that unfinished job and ushered in a new era in which monetary policy was able to sustain non-inflationary growth. He will be remembered as a giant of public policy in the late 20th century.
