September 12, 2003

What Does Alan Greenspan Know That I Do Not?

That was a question I asked Don Kohn at Jackson Hole. I did not get an answer.

Let me explain. Eight times since his appointment to his post as Chair of the Board of Governors of the Federal Reserve, I have thought that Alan Greenspan has made a significant monetary policy mistake. Eight times. And at least six of those eight times, I have been wrong.

I conclude that Alan Greenspan knows things--important things--about macroeconomics, about monetary policy, and about the relationship between economic structure and macroeconomics that I do not.

These eight times are:

  1. Greenspan's rapid reduction in interest rates after 1987 stock market crash. I thought it was excessive--that the links from the stock market to the investment climate were weak, and that Greenspan's policies were likely to spark a substantial runup in inflation. I was wrong about the second--it didn't--and I'm not sure I was right about the first.
  2. Greenspan's not raising interest rates faster in 1988-1989. Once again, I thought he was behind the curve in controlling inflation. Once again, I was wrong.
  3. Greenspan's steep reduction in interest rates in 1990-1991 seemed to me, once again, to run a risk of reigniting the cycle of inflationary expectations. Once again, it did not.
  4. Greenspan's keeping interest rates low until the late winter of 1994 in the interest of supporting Clinton's effort to reduce the deficit and return government finance to balance and sanity. Keeping short-term real interest rates less than zero even as the unemployment rate dropped lower than the Fed staff's then estimate of the sustainable unemployment rate seemed to me to be extremely risky.
  5. Greenspan's bet on a steep reduction in the natural rate of unemployment in 1996-1997. It's now very clear that he was right.
  6. Greenspan's sharp reduction in interest rates in the fall of 1998 seemed to me to be unnecessary. I now think that I was wrong.
  7. Greenspan's failure to reduce interest rates in the summer and fall of 2000 as the NASDAQ crashed. I think I was right: he ought to have moved further and faster to try to headoff the recession that started in the spring of 2001.
  8. Greenspan's not adopting more aggressive measures to reduce the possibility of deflation in 2002. I would have cut interest rates more in late 2002 given forecasts of weak demand growth and of incredibly strong underlying productivity growth. I think I was right, but the jury is still out.

If there has been a single thread to Greenspan's successful policy, it has been an aggressive willingness to take risks to pursue growth and full employment, against a background of a completely credible and ironclad commitment to long-run price stability, and accompanied by extremely good judgment--much better judgment than mine--about where the risks and opportunities for monetary policy are.

I would dearly, dearly love to find out what Greenspan knows that I do not.

Posted by DeLong at September 12, 2003 10:36 AM | TrackBack


I have always blamed the fact that there was an election in the way for #7.

Posted by: theCoach on September 12, 2003 10:59 AM


They should clone him before he dies. The man is truly amazing. The world is lucky that he decided to quit his job as a Jazz musician and go into economics.

Posted by: Joe Willingham on September 12, 2003 11:24 AM


There is an alternative universe out there somewhere in which Alan Greenspan is still playing clarinet and leading the band on the Tonight Show...

More seriously, I agree that I thought his role in the making of fiscal policy in 2001 was disastrous--and predictably disastrous, for you had to be very naive to still have illusions about the Bush Administration then. And I was surprised, especially given his role in setting the deficit on a downward course in 1993, that he would be so eager to tear down such an important part of his own accomplishment.

Posted by: Brad DeLong on September 12, 2003 11:31 AM



The Fed has a reputation for avoiding action ahead of elections, but the only effort I have seen to look into the question found that the Fed has moved rates, up as well as down, as often in the quarter and half year prior to a presidential election as in just about any other period. That does not mean, obviously, that the Fed has never played politics by staying sidelined during an election - some former Fed officials have admitted to discussing the impression that policy decisions during a campaign might leave - and it certainly doesn't mean it couldn't have happened in the one instance you have in mind. The notion that the Fed typically stands pat for elections is open to question, though.


One must consider that a staff of millions, the ability to task staff with finding answers that won't even exist till they do the research, full time attention to the issue of when and how much to adjust policy, all confer advantages. With such advantages, Greenspan may not need to know a specific thing or handful of things you don't, things that could be conveyed to you if somebody would just bother to identify them. Maybe you need to be in that job to do that job.

Posted by: K Harris on September 12, 2003 11:33 AM


There are points neglected. There was a severe banking crisis throug 1990. Several large banks had faltered, the FDIC was low on insurance funds, banking stock prices had fallen sharply. I knew the Fed would have to lower short term rates and keep them low for some time to allow banks to play the spread between short and long term rates and build back earnings.

The international financial crisis of 1998 was severe enough to threaten to halt bond trading, and the Fed and Treasury Secretary Robert Rubin acted promtly to ease credit. Rates fell sharply till October 5, and bonds and stocks rallied.

When the stock market lost 30% of its value in 2 days in October 1987, I think a sharp easing of monetary policy was a simple call.

There were always labor economists who argued strongly and well that we could increase employment more than inflation worriers were suggesting.

I could go on. Alan Greenspan is nicely flexible on menetary policy and looks at many data flows, and there was an especially close relationship with Robert Rubin.

Posted by: anne on September 12, 2003 11:46 AM


You answered your question beautifully in the post immediately below, "On The Advantages of not Having A Theory." Seriously, it is a grave handicap when you are in the analysis business, as a centeral banker must be, I would think, to have even the slightest philosophical axe to grind.

Posted by: Jim Harris on September 12, 2003 11:52 AM


I find it interesting that in each of the first six cases, AG adopted an easier policy than you would have chosen. Was he really right in doing so? The answer probably depends on whether you hold central bankers responsible for the bubbles they create with excess liquidity.

Posted by: NoiseTrader on September 12, 2003 12:15 PM


A couple of days ago I stumbled across the last 30 seconds of Nightly Business Report with another PTAG -- that's paean to Alan Greenspan -- this one by Alan Blinder.

Did somebody bring a bag of "fairy dust" to Jackson Hole this year?

Posted by: Roger on September 12, 2003 12:21 PM


A couple of days ago I stumbled across the last 30 seconds of Nightly Business Report with another PTAG -- that's paean to Alan Greenspan -- this one by Alan Blinder.

Did somebody bring a bag of "fairy dust" to Jackson Hole this year?

Posted by: Roger on September 12, 2003 12:23 PM


I think you are too kind about Big Al and 1994. He held off for a long time on raising rates. But then when the seemingly modest hike did come in Feb 1994, the markets freaked -- big spike in long-term rates, leading to a nasty rout in the bond market and (somewhat indirectly of course), a big headache for Mexico.

Posted by: P O'Neill on September 12, 2003 12:34 PM


No. There were months of warnings that the Fed would reverse policy. Vanguard sent all bond fund holders a letter in September 1993, warning that the bull market in bonds was about to end. The end did come in middle November 1993, when bond prices began falling. There was ample time to alter bond positions accordingly before the Fed acted in February 1994.

Fidelity held a huge amount of Mexican national debt, and though Fidelity was warned of the dangers the company was too enchanted with the easy gains that had been made to protect fund investors from a market turn. Fidelity had played Mexican bonds as though there was no risk.

The Fed tightenings of 1994 caused damage to foolish derivative holders who were sold nonsense by investment houses, but the Fed acted well indeed and experienced investors were not touched and rather did quite quite well.

Posted by: anne on September 12, 2003 12:44 PM


The turns in bonds in 1987, 1991, 1994, 1998, and June 2003 should not have been at all surprising, and that is the point. Alan Greenspan has made Fed policy transparent from 1987 on.

Alan Blinder called the turn in bonds this June perfectly, and pointed out how transparent the Fed has wished to be. Speculators can easily engage in wishful thinking.

Posted by: anne on September 12, 2003 12:50 PM


Speaking of Nightly Business Report -

September 11, 2003

JEREMY SIEGEL, PROFESSOR OF FINANCE, THE WHARTON SCHOOL: The aging of the population is unprecedented in world history. As you know, retirement ages have been getting longer and longer. People are living longer on the one hand and then they're retiring earlier on the other hand. And they're hoping that their accumulation of assets combined with Social Security, other sources of income and pension, is enough for them to enjoy a very, very comfortable retirement period that is getting longer and longer. But the basic wishes of all those retirees flies in the face of the fact that there is not enough workers. that are young enough that can produce all of the goods and services and good things that the Baby Boomers want to buy when they get into retirement. That is the squeeze. There is not going to be enough workers, and on the other side of the coin is that not being enough workers there is not going to be enough people to buy all those assets.

DARREN GERSH, NIGHTLY BUSINESS REPORT CORRESPONDENT: Well, all of the economists say that basically, you know, we need to have a more productive economy, that if we keep productive growing at a good rate, that's what is going to provide for the level of the comfort and security that the Baby Boomers want, the economic level of growth in their retirement, you're not buying that?

SIEGEL: It helps. And I have actually developed a model, a computer model, that puts productivity in. And when I crank up productivity, yes, it helps but not enough.

GERSH: So are you saying we have to go out in the world hire other workers, Chinese workers, Indian workers, to make the goods that the Baby Boomers are going to want in their retirement?

SIEGEL: Well, where I see the answer to the problem is where the young workers are and where are they, in the developing countries of the world: China, India, Indonesia and the other countries. That's where the youth is, that's where the worker population is. Now, do you have to have them immigrate into the United States? No, not necessarily. With worldwide trade they can produce the goods and even many of the services in their home country and then export them to the United States. And the beauty of that is not only are they going to provide us the goods, they're going to earn the income that is going to buy our assets, the Baby Boomer's assets once they retire.

SIEGEL: What you're describing to some people is their nightmare scenario, the idea that we're going to be sending our investment overseas, we're going to be sending our jobs overseas, and you're saying that that's a good thing.

SIEGEL: Well, no, I'm not saying it's a good thing. I am saying that saving is important. I'm not going to deny that, because that is where a lot of innovation takes place, but I do not see enough savings done by Americans and I don't even see how that can even come close, or productivity growth that is good enough to do the job by itself.

GERSH: So what does this mean for somebody who is sitting out there thinking, oh, I have to invest for the next 10, 15, 20 years in my 401(k) if I am going to have a comfortable retirement, and here Jeremy Siegel is saying the stock market is going to crash when the Baby Boomers retire?

SIEGEL: Oh, no, no. Because I do think - what I'm saying is I do think that that solution is going to come into the fore, but I think that U.S. policies have to be knowledgeable and understanding of these forces. In other words, we have to encourage world trade. We have to bring down the terrorists. We have to bring down quotas. We should encourage a bit more immigration because we do need - we are going to have shortages of workers coming up, although I don't see that as the major source of the problem. We have to encourage the rest of the world to grow, not just for their own benefit, not because of charity but because we need their goods going forward.

Posted by: anne on September 12, 2003 12:55 PM


Is there a balance that the Fed needs to strike between interest rates and revenue collection? If the fiscal policy is to collect more revenue as taxes, can the Fed let the interest rates be lower than would be necessary if a lower percentage of taxes were collected? It seems that this is the bargain between AG and the Clinton administration. By 2000, revenues exceeded 20% of GDP. If the government has revenue surplusses, does the Fed have to supply more stimulus to sustain the loss of spending?

Posted by: bakho on September 12, 2003 01:02 PM


It seems obvious, Alan Greenspan has a far better estimate of the market's belief of his own credibility on inflation than you do.

Posted by: CalDem on September 12, 2003 02:00 PM


I'm not a professional economist, just an interested observer, and my questions are sincere.

I've always wondered why inflation is such a huge bugaboo to AG and many corporate eonomists (other than their tendency to see things from the POV of lending institutions.) In my relatively short life, the only serious inflation problem was the supply-shock inflations created by energy costs in the 1970s. The "wage" inflation that AG worries about doesn't seem to be an issue if real income growth is still positive.

I understand the theoretical arguments, but what is the worry when the inflation rates are still under 5% (as they were in the late '80s) or under 3% as for most of the Clinton administration. (note, this is my own back of envelope calculation from BLS CPI stats: percentage change in CPI YOY)

Wouldn't the economy have to be exceeding its long term average by quite a bit to see demand-pull inflation become a problem?

Posted by: apressler on September 12, 2003 02:03 PM


What sort of outcomes could we expect if interest rates were held substantially below equilibrium for an extended period of time?

Abysmally low savings rates?

Historically high corporate and consumer debt?

Formation of asset bubbles as investors shift assets out of savings and safe investments because yields are so low?


Distortion of the balance between labor and capital resulting in both high productivity and high unemployment?

Any of this sound familiar?

Yup, Easy Money Al, my hero.

Posted by: Kosh on September 12, 2003 02:13 PM


You left out has biggest mistake(s):

Pre-Y2K, the Fed Chief feared an old fashion run on the banks (Weimar Republic and all that)

So he cranked up M2 money supply, nearly all of which found its way into the Nasdaq, leading that already bubble inflated market to double in the 6 months from October 1999 to March 2000. (That much gains typically takes 7 years).

IMHO, that was Sir Alan's biggest error, and an obviously unnecessary goof. That made the Bear Market deeper and more severe than it would have otherwise been.

Additionally, it compounded the subsequent error: He ended up cutting rates so low that an unhealthy speculative run (not quite a bubble, but getting there) took place in the bond market and the housing market.

Lastly, he lent his imprimatur to a huge tax cut, which so far, appears ill advised.

Clone him? I'd suggest Cryogenics instead. How's next Monday?

Posted by: Barry Ritholtz on September 12, 2003 03:29 PM


"More seriously, I agree that I thought his role in the making of fiscal policy in 2001 was disastrous--and predictably disastrous, for you had to be very naive to still have illusions about the Bush Administration then. And I was surprised, especially given his role in setting the deficit on a downward course in 1993, that he would be so eager to tear down such an important part of his own accomplishment."

If I was trying to paint his as crafty, I'd say his different recommendations had more to do with keeping a Democrat from increasing the size of the government than worries about the deficit.

Posted by: Jason McCullough on September 12, 2003 03:33 PM


It's better to be lucky than good.

Paul Kasriel, Director of Economic Research for Northern Trust, argues that:

"...the low inflation that has occurred during Greenspan's chairmanship has had a lot do with his luck of the draw. In other words, a Fed chairman would have had to have been really inept to have had a bad record on inflation during the time Greenspan has been chairman. I might add that, in my opinion, Greenspan's successor will not be so lucky."

"The factors that have made Greenspan's job in controlling inflation easier than his predecessors are: the breaking of the back of inflation by Volcker, the decade long stagnation of the Japanese economy, the slowdown in growth of government spending, the end of the Cold War and the economic opening up of China, and the formation of the European Monetary Union (EMU)."

Posted by: Kosh on September 12, 2003 03:55 PM


I think the real question is, "What changed such that Alan Greenspan was a genius and is now much less successful?"

Posted by: Kimmitt on September 12, 2003 05:56 PM


Now that is a classy post. Props to Brad DeLong.

Posted by: John Isbell on September 12, 2003 07:12 PM


I might add to the Kosh list that fuel efficiency standards kicked in during the early 80s and dropped oil consumption by about 25%. Consumption did not return to 1980s level until 2000 when we start to see rises in gasoline prices again.

Posted by: bakho on September 12, 2003 07:25 PM


I'd disagree wholeheartedly with Professor DeLong on point #6: "Greenspan's sharp reduction in interest rates in the fall of 1998 seemed to me to be unnecessary. I now think that I was wrong." Anarchus thinks that Professor DeLong was absolutely correct on #6.

And I further think you can argue that the sharp reduction in interest rates and informal bail-out of LTCM contributed to a bit of a stock market bubble in late 1998 into 1999 . . . . . . and so if the Fed hadn't first erred in reducing rates so sharply in the fall of 1998 to save the Nobel Laureates behinds, and then if the Fed hadn't gone on to dramatically compound that error in its panic over the Y2K thing, then the stock market might not have soared any higher than it was in the spring of 1998 - and if that had been the stock market high instead of the speculative high of March 2000, then Greenspan would have done his job properly by leaning against the wind rather than pouring gasoline on the flames of speculation.

That said, hindsight is 20-20.

However. One important factor not mentioned enough here is the role of debt and leverage in creating inflation. Part of the driving force behind the roaring inflation of the 1960s-1970s was that consumers and corporations weren't too leveraged - so they could easily add new debt to boost financing of demand - pulling future purchase activities into the present, as it were. Once the system has gone from underleveraged, to properly leveraged, to overleveraged (maybe even to extremely overleveraged), it's a lot harder to get a burst of inflation going . . . . . . . not to mention but that in a decontrolled financial environment like we've had since the elimination of Reg Q and other such artifices, real interest rates have remained pretty positive which makes the cost of carrying leverage a meaningful drag.

So a big contributing factor to inflation coming in below consensus expectations in the late 1980s and 1990s has been the drag from higher leverage and higher real interest rates . . . . .

Posted by: Anarchus on September 12, 2003 08:09 PM


The comments above on the *very* unexpected stability in prices in the 1990s accounts for nearly all of St. Alan's miracles. He bet on a low inflation backdrop where consensus views were less optimistic. OK, so he was right, but should a *central banker* be the one with the most optimistic views on inflation?

Posted by: Roland on September 13, 2003 05:31 AM


Just because his policies worked, Brad, does not mean yours wouldn't have.

Also his good judgement seems to have ceased when Bush II entered power. I don't know how much his legacy has been tainted by giving cover for Bush's tax cuts, but it's something I find hard to forgive.

Posted by: Ian Welsh on September 13, 2003 09:13 AM


Could you both be IRRELEVANT

Posted by: greg on September 13, 2003 04:45 PM


Could you both be IRRELEVANT

Posted by: greg on September 13, 2003 04:47 PM


The problems that AG has under Bush43 are a lack of cooperation. AG had great fiscal cooperation under Clintont. Mr. Bush has been uncooperative and out of touch.

Posted by: bakho on September 13, 2003 09:07 PM


>>A couple of days ago I stumbled across the last 30 seconds of Nightly Business Report with another PTAG -- that's paean to Alan Greenspan -- this one by Alan Blinder.<<

Nope, Alan Blinder wasn't at Jackson Hole. It wasn't fairy dust...

Posted by: Brad DeLong on September 13, 2003 09:51 PM


thanks De long
I have to do a thesis about Phillips Curve
and have so many points from your web

I am living in Jakarta, Indonesia.

Posted by: mona minarosa on December 6, 2003 02:04 AM


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