Alan Greenspan defends his monetary policy during the .com bubble: from Alan Greenspan (2004), "Risk and Uncertainty in Monetary Policy" (Speech to the American Economic Association):
Posted by DeLong at April 16, 2004 02:51 PM | TrackBack | | Other weblogs commenting on this postFRB: Speech, Greenspan--Risk and Uncertainty in Monetary Policy--January 3, 2004: Perhaps the greatest irony of the past decade is that the gradually unfolding success against inflation may well have contributed to the stock price bubble of the latter part of the 1990s.4 Looking back on those years, it is evident that technology-driven increases in productivity growth imparted significant upward momentum to expectations of earnings growth and, accordingly, to stock prices.5 At the same time, an environment of increasing macroeconomic stability reduced perceptions of risk. In any event, Fed policymakers were confronted with forces that none of us had previously encountered. Aside from the then-recent experience of Japan, only remote historical episodes gave us clues to the appropriate stance for policy under such conditions. The sharp rise in stock prices and their subsequent fall were, thus, an especial challenge to the Federal Reserve.
It is far from obvious that bubbles, even if identified early, can be preempted at lower cost than a substantial economic contraction and possible financial destabilization--the very outcomes we would be seeking to avoid.
In fact, our experience over the past two decades suggests that a moderate monetary tightening that deflates stock prices without substantial effect on economic activity has often been associated with subsequent increases in the level of stock prices.6 Arguably, markets that pass that type of stress test are presumed particularly resilient. The notion that a well-timed incremental tightening could have been calibrated to prevent the late 1990s bubble while preserving economic stability is almost surely an illusion.7
Instead of trying to contain a putative bubble by drastic actions with largely unpredictable consequences, we chose, as we noted in our mid-1999 congressional testimony, to focus on policies "to mitigate the fallout when it occurs and, hopefully, ease the transition to the next expansion."
* * *
During 2001, in the aftermath of the bursting of the bubble and the acts of terrorism in September 2001, the federal funds rate was lowered 4-3/4 percentage points. Subsequently, another 75 basis points were pared, bringing the rate by June 2003 to its current 1 percent, the lowest level in 45 years. We were able to be unusually aggressive in the initial stages of the recession of 2001 because both inflation and inflation expectations were low and stable. We thought we needed to be, and could be, forceful in 2002 and 2003 as well because, with demand weak, inflation risks had become two-sided for the first time in forty years.
There appears to be enough evidence, at least tentatively, to conclude that our strategy of addressing the bubble's consequences rather than the bubble itself has been successful. Despite the stock market plunge, terrorist attacks, corporate scandals, and wars in Afghanistan and Iraq, we experienced an exceptionally mild recession--even milder than that of a decade earlier. As I discuss later, much of the ability of the U.S. economy to absorb these sequences of shocks resulted from notably improved structural flexibility. But highly aggressive monetary ease was doubtless also a significant contributor to stability.
I wonder why he doesn't mention the tool given in the Securities Laws to control possible bubbles in the stock market: increasing margin rates? It would have been interesting to try that, even if only as an experiment.
Posted by: masaccio on April 16, 2004 03:50 PMWa-Po's title: Paul Krugman, Alan Greenspan's heir?
Posted by: El Gringo on April 16, 2004 04:05 PMSo what's his excuse for the housing bubble?
Posted by: SW on April 16, 2004 05:13 PMDr. Greenspan's argument, often made by him, doesn't hold water. First, increasing margin rates had no risks, and might have reduced the size of the bubble. Second, the reason he didn't tighten rates is not that he was unwilling to pop the bubble, but rather was because he was using liquidity as a tool against the speculative contagion that was roiling international finance markets for 1998-9. Third, he did in fact tighten rates enough to help induce the q3 2000 downturn that helped elect George Bush, but this was too late to reduce bubble. Fourth, if the bubble had been smaller the present imbalances would not need to have been so large, and hence current risks could have been reduced. In short, Fed made mistakes but won't admit them; remind you of anyone?
Posted by: red on April 16, 2004 05:16 PMGreenspan may be right, but I think it is too soon too tell--I want to see how long inflation continues to increase and what happens to the economy when the Fed has to tighten. I suspect we will know whether his policy was as successful as he seems to think it was within a couple of years.
Posted by: Matt Wilbert on April 16, 2004 05:43 PMI agree somewhat with red, though I don't know about the election rigging part. Can't a case be made that Greenspan is changing his story:
"There might be a bubble. The bubble is not as big as expected. We will see. We taken some correction action. There is no bubble anymore. There might have been a bubble but it popped, or if there wasn't and it didn't pop, things are OK and will look up soon. A minor correction unconnected with the bubble, that probably never was. Things will look up soon. Will look up soon. Will look up soon... Will look up soon ... Will look up soon ... Will look up soon. Well, now that things are looking up real soon, it was never our plan to deal with the bubble, it was our plan to make sure things looked up real soon after the bubble popped."
Posted by: jml on April 16, 2004 05:50 PMAnd what is with this mild recession stuff? What has been mild about the labor market, as measured by every indicator, other than unemployment rate. And though the increase in unemployment was mild, the recovery from the mild drop was very lousy, and very lousy for a long time.
Posted by: jml on April 16, 2004 07:01 PMUghh!! "from the mild *increase*"
Posted by: jml on April 16, 2004 07:02 PMSo we are reviewing history here? This is the famous one about 'addressing the consequences of the bubble rather than the bubble itself'. ( This penned over the Xmas holidays spawned something to his name, Alan "Bubbles" Greenspan.) According to his illustrious self, it was absolutely heroic that he fixed that problem...
A bit stale, no? It lacked credibility then and now it seems almost laughable. Let's distinguish between bubbles and consequences of bubbles.
Pass the tweezers.
Please.
Alan Greenspan is the offspring of the Wizard of Oz and Chauncey Gardiner.
Posted by: Eli Rabett on April 16, 2004 07:16 PMThe mistake the Fed made was raising the rates as they did in 2000. The dotcoms would have dot bust without any Fed action and raising the rates in 2000 hurt other sectors of the economy. There was no wage inflation because the labor excess was being picked up by outsourcing.
I agree with his defense of not popping the stock bubble. But I don't agree with the rate increases in 2000.
Posted by: bakho on April 16, 2004 07:17 PMit's unlikely that our host will draw attention to this, so let's do it for him.
http://www.nationalreview.com/nrof_canto/canto200404160821.asp
"On another housecleaning matter I would like to point out that Brad DeLong is not interested in an intellectually honest discussion. A friend of mine tried to post a comment in my defense on his website yet it never appeared. Perhaps he is not interested in the truth"
Hey plod, my friend knows that friend and he says it was computer trouble, not Brad, that wouldn't let the comment through.
I also think my 'friend' is every bit as real as the friend cited in the national review article. Or, Canto's friend doesn't know how to post.
Look, I post and it appears in seconds. Does Canto really mean to suggest that DeLong reviews posts and decides to dismiss the ones he doesn't like? Within seconds, no less? Please. Canto may be bright but he seems to be afflicted with the whiny paranoia most conservatives get afflicted with when they get angry with the left. Two-will-get-you-one he thinks the media is too liberal.
Posted by: cc on April 16, 2004 08:54 PMmake that 'afflicted with the same disease when they get angry with the left'...
the price paid when typing too fast.
Posted by: cc on April 16, 2004 08:56 PMNational Review is a bubble.
Posted by: Susie Dow on April 17, 2004 02:32 AMWhile I am no great fan of Greenspan, I basically agree with his analysis of what the Fed did in the late 1990s.
Raising rates more was a political nonstarter--
at the time both Congress & wall street were claiming rates were already too high.
From his irrational excuberance speech in Dec 1966 until the mkt peak in 2000 the S&P 500
pe rose about 800 basis points. If roughly, a 100 basis point rise in rates leads to a 100 basis point fall in the PE -- what regression analysis suggest -- the Fed would have had to raise rates 800 points to prevent the bubble.
That would have killed the economy -- I do not know anyone that can seriously argue that that big a rate increase would have been a good policy.
On the margin requirement point. THe evidence is overwhelming that margin requirement did not work when they were used from 1950 to 1975.
In regression models using margin requirements I get the wrong sign. If he had raised margins and it failed to dampen the market is would have just added more fuel to the speculative bonefire. So trying to raise margins would not have been a risk free option. The risk and costs of failing were significant.
I am surprised he still cites the higher earnings point in this speech. He used it all through the boom to justify higher Pes, but all he & wall street did in the 1990s was mistake a trought to peak double digit EPS growth for a shift in secular trend. There is no evidence that S&P EPS growth has changed from its 7%
post WW II trend -- 7.5% trend for after tax profits as reported by govt.
I beleive strongly that major reason for stock mkt bubble was a drop in the risk premium
and that was because the economic system had become more stable. Risk of recessions and bear mts fell sharply. Prior to WW II stocks in bear mkt almost 50% of the time -- recessions were also more severe and frequent. This fell after WW II so by 1960 were only in bear mkt about 25% of time. This decline explains rise in mkt pe from 6 in 1949 to 18 in 1960. Probablility of a bear mkt remained stable from 1960 to 1990.
But fell again in 1990s -- in 20 years ending in 2000 mkt only in bear mkt about 11% of time.
If this is a good analysis of bubble than the higher PE just reflected the success of fed in creating a more stable system-- something we all desire and I doubt anyone can believe this is an undesirable outcome.
Given uncertainty Fed policy was reasonable, although not perfect. Also given risk and uncertainty drop in funds to 1% was also reasonable. But it has probably stayed there too long and can be taken back to 3% with only limited risk of significant economic damage
even if that caused a stock mkt correction.
On the National Review being a bubble, I agree. At least when Bill Buckley was alive there was some wit around the joint. Now the rag is nothing but one long sour whine.
Posted by: David Lloyd-Jones on April 17, 2004 07:15 AMGreenspan won't talk about oil.
Inflation=oil.
If oil goes way down in price, our economy booms. No inflation. Even worker's wages can go up, no inflation. Fuel goes up in price, inflation returns. The lull in oil inflation happened because of several one time historic forces, the top one being, Russia suddenly joining world oil markets. This caused a glut.
The oil inflation price market is caused by China and America absorbing all the new excess oil and now the real squeeze is just beginning. This is the Hubbert Peak, everyone. Cheap oil is now going to decrease and expensive oil rise. Ie, the cost of extraction is going to go way up, especially in the Middle East. Look at Iraq: the price there is costing the American tax payer a billion + a WEEK. This is very expensive extraction. Not to mention all the dead bodies littering the landscape.
Greenspan thinks monetary manipulations will "fix" this mess that is looming. It won't but it might make him and his ruling elite buddies insulated from the downeffects of this looming oil crisis.
The fossil fuels are rapidly running out. In today's news is the information that the Gulf natural gas off of Mexico and Texas is running out faster than predicted, indeed, it is collapsing and they don't know if the reserves for next winter (!) can be filled! The price of natural gas is now set to go up much more than last year.
Much of our electricity is generated by natrual gas so that will go way up, too. This means, those people in the south, airconditioning their homes, will have to live with intense heat or not buy other things in order to keep cool (Arizona to Florida, places filled with elderly living in airconditioned homes on fixed incomes!).
This matter is the crux of our economy and few want to talk about this. Right now, inflation for goodies and toys and extras is way down because of China but even this will have to either inflate, degrade or dissappear. You can't make something for nothing. In the original oil crisis which was purely political, we saw commerce nearly totally collapse. I remember those years. When I made a big bonus, I decided to replace all my appliances and entertainment systems and when I went shopping, the sales people were on their knees, crying with joy that a customer showed up.
They even gave me a free TV!
This time around, it won't be so happy. Why buy energy sucking devices when energy is expensive and no hope of it changing? What are we going to do with all those SUV factories? Eh?
Posted by: Elaine Supkis on April 17, 2004 07:23 AM> At least when Bill Buckley was alive there was some wit around the joint.
Bill Buckley, dead?? No, you must be thinking of Alastair Cooke: http://www.deadoraliveinfo.com/dead.nsf/pages/main
Different perspectives perhaps, but something of the same flavor, it always seemed to me. Both hosts on PBS. Imagine Greenspan hosting on PBS. Or rather not.
Posted by: William in Beijing on April 17, 2004 08:23 AM"Inflation=oil."
Elaine,
I agree with you that changes in energy prices have large effects in the short run. Even as we use less energy per unit of economic output the sensitivity to energy prices remains high because it is essential. A sharp drop in energy prices would cause a period of boom without inflation and a sharp rise would cause a stagflation type situation (also for a period of a few years before adjustment of supply and/or demand occurs).
But in your Hubbert peak doom and gloom scenario you fail to consider how we will actually adjust to this shortage of cheap oil. To start with, it's not like oil has actually been made available at $5 a barrel anyway, so if all such oil ran out, I would only be concerned with the effective price of the next technology (which could be on the supply or the demand side) compared with $30 per barrel.
You don't really need to raise the price of oil much to make alternative souces economical. Extraction from oil sands is competitive at prices far below the current price, and Canada is covered with this stuff. Conversion from coal would be doable at the current price, except that nobody thinks the current price will hold (since there are many cheaper projects which could be undertaken first). And don't forget the turkey to diesel plant now operating... even if the cost is much higher than the $15/barrel they claim it could be a widespread thing at $50.
On the demand side, we already know that for five thousand dollars a car we can double the fuel efficiency using hybrid diesel technology. So even at $100/barrel oil, which would about double gasoline prices from current levels, we know the damage is limited to a certain price per car which will decline over time. Sure that price would require some to stop using it to heat homes and would have an impact on air transportation, but $100 is not a realistic price in the L.T. even if every last oil well were to stop producing.
Posted by: snsterling on April 17, 2004 09:35 AMElaine. Canajun eh.
Posted by: big al on April 17, 2004 10:46 AMBack to Greenspan, I am not that familiar with the economics and finance of popping speculative bubbles, versus riding them out and preparing for the aftermath. But I still think my summary of what he actually said is accruate.
Posted by: jml on April 17, 2004 06:05 PMAnd regarding disappearing posts, well, I actually did assume that blogmasters watched all the comments for all the posts simultaneously 24/7. I thought that they walked around with virtual reality glasses and special control throttles that kept them in command second by second. And that this accounted for their odd behavior in public. I've never seen a blogmaster in public or otherwise, but that has been my assumption. I thought that they ran home to their Master Blog Control Board (MBCB) and manipulated things, rubbing their hands and chortling as they heartlessly manipulated us poor defenseless posters.
Does the poster above really mean to sa that they don't?? Well, I'll be a...
Posted by: jml on April 17, 2004 06:11 PMImagine in some future era, a dark star passes close by the earth, invisible until the final moments when it obscures all other light.
At first, the sea's tides would rise a little more than usual, the astronomers would speak of the alignment of the planets, and deep stellar gravitational waves.
Then storm waves would viciously pound coastal cities around the earth, and prognosticators would speak of global warming, the deep ocean currents and unusual high atmosphere synergies.
Last the moon would disappear from view, and the oceans rise from their beds up into the heavens, as we all stared upwards in the final seconds.
Greenspan's economic theory is antiquarian. When several billion people in China behind a martial central economy set their sights on a complexly limited and highly futured source of strategic commodities, nothing Greenspan or the Fed does with US interest rates will have the slightest effect on that dark star rising, except to crush Americans under a tidal wave of interest debt.
Lemmings, the Fed will lead us all into the sea.
Lockstep, goosestep, astrologically seig-heil'd.
Look! What's that up in the sky?
"Raising rates more was a political nonstarter--
at the time both Congress & wall street were claiming rates were already too high."
But isnīt the Fed supposed to be the worldīs most independent central bank? spencer, there must be better arguments than this one.
Personally, I prefer Greenspan's older writings, say from 1966:
http://www.lewrockwell.com/north/north204.html
Posted by: Over Here on April 18, 2004 10:01 AMI am surprised by the number of posters who find that the Fed has done a great ( atleast 'good') job of managing our economy despite it's current state.
Apparently, PK's general view of "looting the future", SR's indefatiguable " global imbalances", and many other luminaries's views are apparently not as persuasive as AG's defence.
Are we looking back and thinking 'It was an interesting time with not a few crises. But we made it, thanks to astute monetary decisions of our central bank.'?
And looking ahead?
Why would anyone do that?!!
Mr. Greenspan's comments in this speech to the American Economic Association are contradicted by his comments in the September 24, 1996 FOMC meeting when he declared a stock market bubble present. To see the contrast go to http://64.29.208.119/archive_comm_article.asp?category=Guest+Commentary&content_idx=31215
Mr. Greenspan's comments in this speech to the American Economic Association are contradicted by his comments in the September 24, 1996 FOMC meeting when he declared a stock market bubble present. To see the contrast go to http://64.29.208.119/archive_comm_article.asp?category=Guest+Commentary&content_idx=31215
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