The past decade has not been kind to Alan Greenspan. Ten years ago, he was widely viewed as one of the most successful Federal Reserve chairmen of all time, the central-bank “maestro” whose policies had sustained the so-called Great Moderation — i.e., the reduction in economic volatility — that began in the 1980s. “His performance has indeed been remarkable,” the late conservative economist Milton Friedman wrote in January 2006. “There is no other period of comparable length in which the Federal Reserve System has performed so well. It is more than a difference of degree; it approaches a difference of kind.”
Since then, of course, we have experienced the worst financial crisis since the 1930s, a deep recession, and a painfully slow recovery. Greenspan’s reputation has suffered tremendously, with many people arguing that his incompetence, complacency, and/or ideology fueled the growth of the housing bubble.
While Greenspan did not deserve the extravagant praise he received during the pre-crisis years, he does not deserve the vitriol that’s been heaped on him since 2008. In a recent Wall Street Journal essay adapted from his new Greenspan biography — which was published Oct. 11 — journalist Sebastian Mallaby explained that popular perceptions of the former Fed chief are “startlingly wrong”:
Far from being an omniscient sage, Mr. Greenspan was plagued by doubts about the Fed’s direction. He wondered aloud whether the calm in the economy and his own exalted reputation might be leading to trouble. “When things get too good, human beings behave awfully,” he once remarked to his colleagues.
And far from being a confident believer in the self-policing efficiency of markets, Mr. Greenspan agonized about their instability. He frequently reminded listeners of the crash that ushered in the Great Depression — only to witness the financial crisis of 2007-08, which brought his maestro status (and much else) to an end.
As part of his book project, Mallaby obtained Greenspan’s 1977 doctoral thesis, which described the Fed’s creation as “one of the historic disasters in American history.” In Mallaby’s words, Greenspan argued that “the Fed had an obligation — a clear and inviolable duty — to avoid printing the money that fueled financial bubbles.”
Why, then, did he not take stronger actions to prevent the housing bubble? Mallaby believes that, as a veteran of Washington politics, Greenspan “calculated that acting forcefully against bubbles would lead only to frustration and hostile political scrutiny.”
In an interview with the Journal’s Greg Ip, Mallaby noted that Greenspan’s Fed “tried more than we realized” to improve housing and financial regulations prior to the crisis. “The real mistake,” in Mallaby’s view, “was not to push with interest rates.”
Ryan Avent of The Economist disagrees, arguing that structural economic forces have made it harder for central bankers to raise long-term interest rates:
The right conclusion to draw from the experience of the 2000s is not that Mr. Greenspan showed poor judgment and weakness in failing to punish American households with more rate hikes. The right conclusion to draw is that Mr. Greenspan’s options were constrained by global macroeconomic dynamics that were poorly understood at the time, and to which he responded about as well as could be expected. The financialisation of the global economy has clearly affected the operation of monetary policy. The interest rate that matters now is the global real interest rate, and national central bankers face constraints in setting domestic monetary policy as a result. As a result of those constraints, central bankers cannot easily raise long-term borrowing costs, since efforts to tighten policy attract capital inflows. Weak demand is a chronic condition in this world, outside of circumstances in which asset prices are growing rapidly or government borrowing is used to prop up demand. It is somewhat extraordinary that in the wake of the crises of the last decade we are more open to the idea that growth should be slower, and slumps deeper and more frequent, than to entertaining the possibility that the benefits of free capital flows might not be worth the macroeconomic costs, and that governments should bear greater responsibility for stabilising demand. If Mr Greenspan’s career teaches us anything, it is that we should not expect too much of our monetary maestros.
The debate over Greenspan’s record and legacy will continue for years to come, as will the broader debate over what caused the financial crisis. Yet it now seems pretty clear that, even if Fed policy was too loose between 2003 and 2005, America’s central bank simply does not have the influence that many ascribe to it.