Alan Greenspan: “The Maestro”?

Yesterday Bush formally nominated Alan Greenspan for his fifth four-year term as chairman of the Federal Reserve Board. In his written statement accompanying the nomination, Bush said that “Alan Greenspan has done a superb job as chairman of the Board of Governors of the Federal Reserve System, and I have great confidence in his economic stewardship.”

Many in the financial world agree; in fact, Greenspan is often referred to as “the Maestro” of economic policy-making in the business press. “Maestro” was even the title of a Bob Woodward book about Greenspan. Is such high praise warranted? My answer is an unambiguous no.

For historical context, the following chart shows the Federal Funds rate (the interest rate most directly controlled by Alan Greenspan) since the year before Greenspan took the helm of US monetary policy in 1987.

How good was Greenspan’s management of interest rates during this period? Let’s take a look at some important episodes.

October 1987: The stock market crash. Greenspan received widespread credit for quickly injecting liquidity into the US economy, helping to prevent the stock market crash from affecting the economy more generally. He probably did the right thing, though it would have taken an idiot to fail to recognize that increased liquidity was needed immediately after the stock market crash.

1989: The economy was booming. Greenspan tried to engineer a “soft landing” by raising interest rates enough to slow the economy from the heady pace of 1988-89 without sending the economy into recession.

1990-91: Greenspan’s “soft landing” clearly failed. He raised interest rates too high to fast, the US economy entered a recession, and he immediately (but too late) had to reverse course and lower interest rates.

1991-93: Greenspan tried to help end the recession by reducing interest rates. He lowered them slowly, however, and arguably not far enough. Though the recession was deeper than the 2001 recession, interest rates never went below 3%, and only reached that level in late 1992 – a full two years after the worst part of the recession.

1994-95: The economy was recovering smartly. Greenspan implemented a sharp increase in interest rates, wreaking havoc in the bond markets. The rise in interest rates was so sharp and fast that the US economy slowed dramatically in 1995, and nearly went into recession. Once again, Greenspan had to reverse course and quickly lower interest rates to undo his overeager increases.

1998: The failure of Long Term Capital Management (LTCM). The collapse of this hedge fund nearly paralyzed the US’s entire financial system. It was a financial disaster narrowly averted by careful Fed action (mainly in the form of coercing major banks to help out LTCM). However, Greenspan had little or nothing to do with this; it was NY Fed chairman William McDonough who orchestrated this narrow escape for the US economy.

1996-2000: The boom of the 1990s. Greenspan did virtually nothing to change monetary policy. The economy did great. However, financial and investment bubbles gathered strength and set the stage for the extremely sharp contraction in both the stock market and business investment in 2001. Many have argued that a tighter monetary policy during this period would have prevented a lot of future economic pain. On the other hand, few have argued that the strong US economy of the late 90s was due to magical monetary policy-making.

In short, I think that Greenspan has done some things correctly (including the sharp reduction in interest rates in 2001-02), but has also done many things clumsily. Far from being a master of monetary policy, I would describe his performance as mediocre.

In addition to his handling of interest rates, one might also judge Greenspan based on the advice and counsel that he has given the president, Congress, and the financial markets over the years. In this category, I would describe his performance as awful. He has talked of financial excess without doing anything about it; advocated tax cuts when the vast majority of economists could see that they were clearly fiscally irresponsible; and used his position to advocate his personal preference for a reduction or elimination of the Social Security program.

Put it all together, and I think that it’s time for a new Fed chairman. But it looks like we’ll have to wait a few more years.

Kash

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