September 04, 2003
More Thoughts on Jackson Hole
Still more disconnected thoughts from Jackson Hole...
One of the interesting things that I noticed at the Jackson Hole conference was that there had been a crystallization of near-consensus opinion about why the Greenspan-era Federal Reserve has done so well. The near-consensus position was that the sources of good performance were four:
- Very good judgment by Chairman Greenspan--good judgment reinforced by the fact that because he is not an academic he is able to abandon theories, models, and rules of thumb when the data suggest that they are wrong, as opposed to the academic tendency to hang on to the theory long past the point of no return.
- Universal and solid confidence that the Federal Reserve will never compromise on its long-run goal of price stability.
- As a result, enormous freedom for the Federal Reserve to take aggressive action to stabilize production and employment in the short run--freedom that a central bank whose commitment to price stability was questioned would never have.
- Substantial confidence by private-sector agents in the Federal Reserve's commitment to price stability--hence substantial stabilizing speculation in all kinds of markets that smooths out the consequences of macroeconomic shocks.
What struck me as most interesting was--as I said at the conference--that this is very close to Barry Eichengreen's theory of why the pre-World War I gold standard was so successful. An unquestioned commitment to the gold standard by industrial core central banks allowed them to focus short-run policy on the domestic situation, and private-sector agents frontrunning kept central banks from having to intervene to smooth out any destabilizing capital flows.
The Bundesbank had a similar sterling reputation--hence it had enormous freedom to focus short-run policy on the domestic situation (which it did not, by and large, use). It will take a while for the ECB to develop its own sterling reputation. In the meantime, ECB policy will have to keep one eye (or two eyes) on the problem of building reputation and shoring up credibility. This makes me wonder whether the coming of the euro will turn out to be even more costly for Europe than I had thought.
Posted by DeLong at September 4, 2003 08:13 PM
"Very good judgment by Chairman Greenspan--good judgment reinforced by the fact that because he is not an academic he is able to abandon theories, models, and rules of thumb when the data suggest that they are wrong, as opposed to the academic tendency to hang on to the theory long past the point of no return. "
Do you mean it might be OK to abandon a free trade theory that was postulated 200 years ago under greatly different circumstances?
That today is causing such job lossses and demand leakage that its costs outweigh its benefits for a large portion of the population?
Refer to the Okun's law post below for data. If the bedrock of economics is to maximize efficiencies, what is to be done when maximizing effiencies hurts most of the population?
ps--I am NOT pressing the post button twice
1) Irrational Exuberance in 1996 -- stating stocks were significantly overvalued -- was replaced by Productivity Miracle, which even after the identification of the bubble, allowed it to inflate further;
2) Oh, no, Y2K! Erroneously fearing a cash run on the banks (I guess he felt he were more like the Weimar Republic than the US), the Fed panicked and flooded the economy with cheap money by radically increasing M2.
How much money supply did the Fed flood the system with? Starting in October 22, 1999, until 6 months later, March 2000, the Nasdaq doubled. Traditionally, those level of gains take 7 years.
Near-consensus opinion that the Greenspan-era Federal Reserve has done well? I suppose not many critics from Wall Street were there. We have a very different perspective of Greenspan's tenure.
The Euro will soon face the rock of a French budget deficit that, for the third year and prolly fourth, busts the Stability Pact (hard place). Only if the ECB/ commission can fine France will there be real trust.
I doubt it. But then, redefining the Pact to accept 4% deficit might be the quick & easy way out... possibly which can save the Pact this cycle.
Unless/ until France is disciplined, the Euro will never achieve that level of trust. Though it might get accepted despite this, for other reasons (oil-dollar diversification, increasing US debt, great profit opportunities in CEE).
How is #2 different from #4?
#2 and #4 seems to frame up a vituous cycle interlocking trust in the fed (or the man) and how effective it's responses to shock can be. That's one point, not two.
Let's ask about falsifiability - what would it take for economists to downgrade their opinions of Greenspan? Actually, to be truly falsifiable, what were these people saying 5 and 10 years ago?
I have a sneaking suspicion that part of the cult of Greenspan is an unwillingness to credit Clinton with anything save luck.
"It will take a while for the ECB to develop its own sterling reputation."
Um, let's not forget our Asian friends. The U.S. must also give muchos thanks to Japan and China, who are sending over good stuff like toys and digital cameras and accepting in return as payment useless bits of paper called dollar bills. On the other hand, maybe the reason they are so foolish to continue in the scheme is that they have great confidence in Alan G.
The AG tenure was accompanied by return to sound fiscal policy and a willingness of the Clinton administration to work with AG. Now that AG is trying to fix the US economy with monetary policy alone and no fiscal help from the current administration, he is struggling. You cannot divorce the fiscal environment from the success of AG.
Is there any chance that employment history has something to do with Greenspan's success? Crediting his lack of an academic anchor (suggesting the DeLong's of the world are unsuited to run monetary policy) casts the issue in a negative light - what Greenspan isn't. What he is is among the most successful consulting economsts around. He has worked in the White House. Between the two, he has been responsible to get his forecasts right (rather than sell financial instruments to clients under cover of making economic forecasts, like some investment house economist) or lose business, and to give advice to policy makers in a way that is politically digestable. Can we get Larry Meyer some White House time?
I completely agree with Barry Ritholtz and Andrew Boucher. Numbers about monetary aggregates don't seem to matter anymore on Wall Street and receive little attention nowadays. I'm afraid that the "stellar" economic performance of the United States in the past decade has a lot to do with loose monetary policy by the Fed, as well as the willingness of foreigners to buy US assets, many of whom who still believe in the paradigm of economic outperformance (productivity growth) by the USA. Actually, the outperformance in productivity by the US (compared to Western European economies ) is relatively minor (0.2%) if you look at data of the past decade. Liquidity (not productivity) , amply provided by the Fed in 1995 (Mexico crisis), 1998 (LTCM) and 2001 (aftermath of stock bubble), is key to understanding why the USA experienced a boom during the late 1990s and also why the recent recession was relatively mild. IMO, the real bust still has to come and I think that economic historians won't be kind to Mr Greenspan.