Good article on Alan Greespan in today's Barrons:
interactive.wsj.com
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Fortunate Son
Until now, Greenspan has been more lucky than right
By Gene Epstein
You had to be there to believe it. At a conference last month at Boston
College, Edward J. Markey, the Democratic Representative from
Massachusetts, introduced the keynote speaker, Federal Reserve Chairman
Alan Greespan, as the "Babe Ruth of our economic policy." Greenspan
looked a bit overwhelmed, but expressed his thanks to the adoring crowd. So
imagine the shock if the Fed chairman's characteristic modesty had gotten the
better of him. At that point, he might have added: "For the sake of accuracy,
and before this idolatry gets out of hand, I have to say I'm hardly the Babe
Ruth of our economic policy, but you could call me the Casey Stengel," in
what would have been an apt analogy to the manager of the New York
Yankees' during their halcyon years of the late 'Forties and 'Fifties. Not
because of the shared proclivity of the Fed head and the Ol' Perfesser for
sometimes impenetrable syntax, but owing to Stengel's Bronx Bombers' ability
to win championships seemingly without effort. "The economy keeps hitting
'em out of the ballpark no matter what I say or do," Greenspan might have
said. Or, as Casey once put it, in his tortuous way: "Managing is getting paid
for home runs someone else runs."
Now picture the Fed chief taking the same truth serum when he sought
approval for another four-year term before the Senate Banking Committee in
January. Perhaps to assure him that his application was a shoo-in, Phil
Gramm, the panel's Texas Republican chairman, gushed that if "forced to
narrow down the credit for the Golden Age we find ourselves living in. . .,
your name would have to be at the top of the list."
To which our applicant ought to have responded: "But Senator, before you
give me too much credit, I have to confess that I would have prevented this
Golden Age from happening if I'd ever known it was coming."
It's past time to puncture the myth of the masterly Alan Greenspan.
Since 1996, the economy has been enjoying an accidental boom, accidental
because the Fed chairman would have stopped it in its tracks if his cloudy
crystal ball hadn't prevented him from doing so. Because he continually
expected the boom to moderate, even though it never did, he stayed his hand.
But despite his perennial prediction that
the Goldilocks economy -- neither too
hot nor too cool, but just right was just
around the corner, what we got instead
was the 4X4X4 economy: four straight
years, from 1996 through '99, of gross
domestic product growing at better than
a 4% real rate, and the unemployment
rate steadily declining to a 30-year low
of 4% this past January. And given the
surprising strength of the current quarter,
2000 is now shaping up as the fifth
straight year of 4% growth, with
joblessness likely to fall even further.
If the central bank's forecasting model had been fed those numbers back in
early '96, then its inflationary alarms would have been set off. Back then, the
conventional wisdom held that a 2 1/4 %-2 1/2 % rate of GDP growth and
unemployment at slightly less than 6% was the best the economy could do
without igniting inflation. Mainstream economists had codified that level of
joblessness as the NAIRU-the non-accelerating inflation rate of
unemployment. NAIRU rules dictated that when unemployment went as much
as a half-point below 6%, inflation would pick up.
What we got instead was a case study in Murphy's Law -- in reverse:
Virtually everything that could go right, did. We saw strong growth, soaring
incomes and low unemployment, tame inflation; a bull market in equities that
turned out to be at least half right about surging profits, plus the pleasant
shock of a federal government that was beginning to spend less than it was
taking in. If the Goldilocks targets had been in force over the past four years,
inflation would be even lower but unemployment could be nearly two
percentage points higher, which would translate into three million fewer
people holding jobs. With economic growth compounding at an annual rate
nearly two percentage points lower, gross domestic product, which stood at
$9.5 trillion as of the fourth quarter, would be close to a trillion dollars less.
And with slack labor markets, income gains would have been more modest,
and the well-being of Mr. and Ms. Median might have barely improved. Real
median household income, which lost ground in the early years of this
expansion, by 1996 finally exceeded the peak of 1989, and is now about
10% higher.
To be sure, if the boom hadn't happened, then the Fed chairman might be
blessedly free of some of his current headaches: the Internet bubble, massive
trade deficits, signs that bank lending is tilting toward excessive risk and that
inflation is creeping upward.
But if those problems don't sow the seeds of the expansion's destruction, and
the proverbial soft landing can be achieved, then the give-growth-a-chance
ethos of the past four years will be redeemed. Not so much for the riches
generated by the bull market as for providing an economic environment that
permitted welfare reform to succeed.
Giving growth a chance never was Greenspan's
main objective. He had inherited the mantle of
inflation-fighter from his illustrious predecessor,
Paul Volcker, and firmly believed in maintaining
the standard speed limits in order to keep
inflation at bay. But the far-from-omniscient Fed
chairman found that the economy didn't follow
the script.
The myth of the masterly Greenspan owes much
to the admiration of mainstream economists,
who shared the same forecasting errors, and the
mainstream media, especially those within the
Washington Beltway. But to the Fed chief's
credit, as unfolding events kept contradicting his
blueprint, as growth remained stubbornly robust, and as the jobless rate kept
cracking through NAIRU thresholds, he took notice of the fact that inflation
wasn't doing what he and most forecasters had said it would.
When an old paradigm begins to get riddled with such a serious anomaly, the normal reaction among
those older scientists is to cling to the flawed paradigm, while the new approach gets adopted by younger
and more flexible theorists. How flexible could we expect a theorist to be who had already lived through
his three-score-and-ten?
And to compound the problem, this theorist was a central banker with the stated need to act preemptively,
before he saw the whites of inflation's eyes. For as he himself had declared more than once, "Because
monetary policy works with a lag, we need to be forward-looking, taking actions to forestall imbalances
that may not be visible for many months." And he could have taken satisfaction for having done just that.
In February 1996, Greenspan told the House Banking Committee that the economy appeared to be on the
path of sustainable growth, having slowed from 1994's seemingly torrid pace, which then was measured at
3.5% (it's since been revised upward). That followed the Fed's series of increases in the federal-funds rate
-- the overnight interbank lending rate that the central bank targets, giving it effective control over the price
of short-term credit -- that boosted the key rate from an accommodative 3% in early 1994 to 6% only a
year later.
As Greenspan put it to the House Banking Committee in February 1996, "We moved [short-term interest
rates] in 1994 to levels more consistent with sustainable growth. Our intent was to be preemptive -- to
head off an incipient increase in inflationary pressures and to forestall the emergence of imbalances that so
often in the past have undermined economic expansions."
He then went on to crow that "as we entered the spring of 1995, it became increasingly evident that our
policy was likely to succeed." The economy had indeed slowed -- so much so that the funds rate target
had been eased back to 5 1/4% in three successive quarter-point steps. Result: "The economy, as hoped,
appeared to have moved onto a trajectory that could be maintained -- one less step than in 1994, when
the rate of growth was clearly unsustainable."
But what exactly was a sustainable rate of growth? Presumably, the Fed chairman's stated expectation for
1996 that growth would run "2%-2 1/4%." With growth coming in at more than a percentage point higher
in '96 (in fact, still another point higher, based on subsequent revisions), Greenspan appeared again before
the House Banking Committee in February with no mention of his errant forecast, as was his custom. But
he did feel the need to explain why he hadn't hiked the fedfunds target, even though growth had returned to
the "unsustainable" level of '94.
To begin with, he was clearly impressed by the "benign inflation outcome of 1996." Contrary to his
forecast, unemployment had fallen from 5.6% in December '95 to 5.4% by the end of '96. But even
though there was some response in wages, "the rate of pay increase still was markedly less than historical
relationships with labor market conditions would have predicted."
Greenspan tried to explain the anomaly, implying that perhaps NAIRU rules had to be revised. "Atypical
restraint on compensation increases has been evident for a few years now and appears to be mainly the
consequence of greater worker insecurity." While he noted those fears were waning, he added that the
monetary authorities "thought inflation might well remain dampened, and in any case was unlikely to pick
up very rapidly, in part because the economic expansion appeared likely to slow to a more sustainable
pace."
Once again, he gave his definition of sustainability, predicting in February '97 that GDP growth for that
year would slow to "2%-2 1/4% over the four quarters of the year" and that the unemployment rate " . . .
should stay around 5 1/4%-5 1/2% through the fourth quarter."
And once again, he missed by miles, this time by an even greater margin. Despite tweaking fed funds back
up to 5 1/2% in March, GDP grew nearly 4% (even higher in subsequent revisions) and joblessness
plunged from 5.4% in December 1996 to 4.7% by the end of '97.
But as always, he showed his flexibility. In his February '98 testimony, he explained why "we did not
increase the federal-funds rate again during the summer and fall, despite further tightening of the labor
market." The Fed stood pat because "measured inflation fell, owing to the appreciation of the dollar,
weakness in international commodity prices and faster productivity growth."
The firm dollar and soft commodity prices might be temporary factors. But faster productivity growth
could be a more permanent damper on inflation. The Fed chairman increasingly sounded this note in
numerous speeches, and thereby gained his reputation for being open to the New Economy nostrums.
In early '98 and '99, as the chart on page 32 shows, Greenspan again mistakenly predicted a return to
"sustainability." The boom continued on its merry way. That was fueled in no small part by his easing of fed
funds back to 4 3/4% in response to the international capital-market swoon of the summer and fall of 1998
-- and in the face of robust expansion of the U.S. economy.
The Greenspan of today appears to have gotten the message, at long last, about the economy's underlying
strength. "There is little evidence that the American economy, which grew more than 4% in 1999 and
surged forward at even faster pace in the second half of the year, is slowing appreciably," he told Congress
this February. Accordingly, the overnight rate is back up to 6%, and further hikes are almost inevitable.
And the time seems right for Greenspan to see the light at long last. As noted, the "stretch marks" in the
economy are becoming all too apparent, and the accidental boom needs to be reined in. Just how
Greenspan deals with it will help shape the economy's fate.
Will this portrait of our fumbling Fed chairman do harm? It's been argued that faith in Alan Greenspan's
infallibility helps keep the economy going. Sen. John McCain even made the now-famous suggestion that
Greenspan be kept on past his demise, propped up like the title character in the film My Weekend at
Bernie's. However, when the Fed chairman's current four-year term is up, he'll be celebrating his 78th
birthday, at which point it's not unreasonable to expect that he'd retire.
That trauma might be easier to face if we can view Greenspan not as some legend but as merely mortal. As
Casey Stengel would have said: You can look it up. |
