September 14, 2002
Greenspan 5, DeLong 2

"You know me," said one senior Federal Reserve policymaker of the 1990s, "and on the inflation-unemployment tradeoff I'm dovey-dovey. I'm not prone to undercount the distributional and productivity benefits from low unemployment. I'm not prone to overweight the costs of moderate inflation. Yet there I was, in the Chairman's [Greenspan's] office, beggin him to raise interest rates. The NAIRU [the unemployment rate at which inflation is steady] couldn't have fallen that far. Potential growth couldn't be that fast. But he would say, 'It doesn't feel like an economy in which inflationary pressures are building'. And he was right.

Whenever we monetary economics types get together, sooner or later the topic of conversation turns to Alan Greenspan. "He's not a God," somebody will say. We will agree that he's not a God. "He has a hard time giving a coherent explanation of why he holds his views," someone else will say. We will agree. Often, after a Greenspan explanation, our only reaction will be, "Huh?"

"But why is his judgment so good? Why is he so right so often?" someone else will say. And we will have no answer. He knows things about how to analyze the modern business cycle that we do not. As I've said before, my personal scorekeeping has Greenspan 5, DeLong 2 on the seven occasions I can think of since 1987 when I've seriously disagreed with his monetary policy--and that's with my scorekeeping.

Like the operation of the Digital Conveyer, the making of monetary policy seems to be more art than science. Yet I do have one wish: I do wish that Alan Greenspan had several good apprentices, people who know how he thinks and how he reaches his judgments. Because this is a powerful piece of social knowledge that he has--but that I cannot think of anyone else who shares.

Posted by DeLong at September 14, 2002 01:45 PM | Trackback

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Though I agree that we have had fine monetary policy since Alan Greenspan became Fed Chair, I have been troubled by what seemed a gratuitous support for the tax cuts of this administration coupled now with a warning to Congress to tighly control expenditure.

Perhaps economic growth will be strong enough in the near term and over the next several years, and so enable us to continue to meet important social need such as providing for social security and medicare given a rapidly aging population. Perhaps, but I am concerned.

Posted by: on September 14, 2002 02:17 PM

I have to agree with you. And reading his latest in favor of tax cuts, he comes across not so much in favor in cuts, but more of a "it's really too late to do anything about them now, and I don't want to give the impression that I've changed my mind." feel. His defense of the cuts just didn't seem to have much feeling to it.

Posted by: Dennis O'Dea on September 14, 2002 04:18 PM

Digital conveyor. Impressively obscure.

Posted by: Paul on September 14, 2002 05:21 PM

Post-Greenspan succession to chairmanship is a real concern indeed, especially given how irrational markets can be at times. Besides, imagine W trying to choose a good chairman... I wonder if he'd consider O'Neil seriously...

However, I believe there is no magic behind Semi-god Alan Greenspan's ability to predict. It's this guy's full time job (while Professor DeLong's interests span many other topics). He is surrounded by experts who have the best available data and anecdotal evidence at their fingertips. Further, he gets to hear many DeLongs' extensively articulated arguments for this, that and their contrary.

Also, I believe it's a lot easier to be a good Alan Greenspan than to be a good Paul Volker. The job is inherently more forgiving. You "just" have to ride the tide (and not mess it up, course...) In this case, it's in the not over-riding the tide that inevitably the job gets to be judged. On this account, Saint Greenspan is not discharged of all charges yet, it seems.

Professor DeLong, congratulations on your 2 points! It's not easy to outsmart the Fed (especially given how large a player it is, and that the law is on its side, for good reasons.) Everyone on Wall Street would like to, but many loose some people's money doing so.

Posted by: Jean-Philippe Stijns on September 14, 2002 07:26 PM

I always assumed the Greenspan-promoted elevation of his longtime associate Don Kohn was an effort to bring continuity of thought to the Board.

And Greenspan's well-known affinity for Vice-chair Roger Ferguson as the "Mr. Inside" nuts & bolts administrative/regulatory guy makes succession planning fairly straight-forward, from a pure process persective.

Ferguson's status as a Democrat and African-American actually makes him an easy choice politically to assume the top spot.

As Greenspan's approved insider, he's not likely to be assaulted from the right, despite his party affiliation, and it's impossible to envision Democrats opposing one of their own.

Posted by: George Zachar on September 15, 2002 04:32 PM

Is it opportune to raise the question of the FED's precise mandate?

Please correct me if I'm wrong but to a distant observer it appears that by the (recently established) standards of the Bank of Enland (BoE) and the European Central Bank (ECB), the FED appears to have an unusually flexible mandate from Congress and the Board of the FED can itself select whether to target inflation or the output gap or some trade-off between the two, at least in the short-term, or the money supply, however defined.

I raise the question since, as you will know better than I, much print has been expended in debating the respective merits of the BoE's precise symmetric remit from the UK's Parliament to maintain the inflation rate at 2.5% within +/- 1% and the ECB's own adopted remit of maintaining the inflation rate within an upper bound of 2%. Neither central bank is expected to address output or unemployment targets, at least not explictly. Some commentators have accorded much significance to the differences as well as to the decision making process in setting rates and as to whether minutes of the proceedings and voting record are made public, as in the case of the BoE, or not. Unless I am greatly mistaken, none of that debate has had much influence in America. If so, no criticism is implied on my part, though compatriots may not agree. On the whole, as you say, the FED has been doing a pretty good job. Arguably the really difficult question is whether central banks anywhere should adopt a more proactive stance on dealing with asset bubbles and, if so, how?

Posted by: Bob Briant (UK) on September 15, 2002 05:26 PM

The real score is: Greenspan 0 Yield Curve 68.
There has not been a single Fed move that was not predicted in advance by the eurodollar futures, often months in advance. The true social knowledge exists in the market, and no economist on Wall Street or at the Fed or elsewhere can beat the predictive power of the yield curve over time.

Posted by: Peter vM on September 16, 2002 04:31 AM

The real score is: Greenspan 0 Yield Curve 68.


As Greenspan and others at the Fed have discussed publicly for years, the FOMC and the market are in a constant dialogue about the future and intentions.

The Fed signals/hints, the forward curve shifts, the Fed acts, the curve is "ratified".

Who leads in this arcane dance? The answer is not binary.

Posted by: George Zachar on September 16, 2002 04:52 AM

Whose law is it that says that as sone as you base monetary policy on a single leading statistic, the correlation between that statistic and the economy immediately falls apart? I feel like I have it on the tip of my tongue... er, fingers.

Julian Elson

Posted by: Julian Elson on September 16, 2002 08:19 AM

Goodhart's Law

Posted by: Daniel Davies on September 16, 2002 09:42 AM

To George Zachar

Exactly right. That is why there is a parade of Fed officials shaking things up with public comments ahead of FOMC meetings when the eurodollar market is not accurately pricing in the results of the up-coming meeting, bland confirmation of market pricing when things are priced right. The lack of surprise is due to well-practiced communication by the Fed.


Posted by: K Harris on September 17, 2002 11:12 AM

Bob Briant wrote:
"the FED appears to have an unusually flexible mandate from Congress and the Board of the FED can itself select whether to target inflation or the output gap or some trade-off between the two, at least in theshort-term, or the money supply, however defined."

In 1949 Congress passed a bill called the Full Employment Act that mandated all Federal institutions to promote low inflation AND low unemployment. This has been reaffirmed since then. Hence Mr. Greenspan's periodic reports top Congress. So yes there is a mandate that says something like, "keep inlation low (you figure out how low) and unemployment low (you pick a number). " The important thing is that both are included while they are not included in the European context. Why?

Posted by: Lawrence Boyd on September 17, 2002 01:48 PM

the yield curve is far ahead of the Fed. The Fed does not lead. Note how the last recession, and the 8 recessions before that were preceded 12 months in advance by an inverted Treasury yield curve. There have been no false predictions in between, and no economist, inside or outside the Fed has been been as far sighted. Inded Fed rhetoric often been in the opposite direction to the curve. There are Fed research papers on the predictive power of the yield curve, and why it beats all policy makers and outside analysts.

Posted by: on September 17, 2002 10:56 PM

The question is, is Greenspan really brilliant, or is he just the monetary equivalent of those mutual fund managers hugging the tail end of the distribution? And how can you tell which is the case?

Posted by: Jane Galt on September 18, 2002 11:51 AM

Greenspan has more information about the market than anyone else, and he gets it before anyone else. Someone in the private sector could hold the world up for ransom with what he has; is it so surprising he consistently wins?

Posted by: Jason McCullough on September 18, 2002 02:06 PM

Well, if I initially thought it was 50-50 who was better, 5-2 is good enough to make me think it's 84-16 he's better...

Posted by: Brad DeLong on September 18, 2002 02:25 PM


>>In 1949 Congress passed a bill called the Full Employment Act that mandated all Federal institutions to promote low inflation AND low unemployment. This has been reaffirmed since then. Hence Mr. Greenspan's periodic reports to Congress. So yes there is a mandate that says something like, "keep inlation low (you figure out how low) and unemployment low (you pick a number). " The important thing is that both are included while they are not included in the European context. Why?<<

Thanks for that direct quote from the Full Employment Act (1949). It neatly illustrates a fashion on both sides of the Atlantic in the immediate post-war years for legislators to enjoin appointed public servants to achieve "good things" while leaving decisions as to means and trade-offs to their discretion. Stalin may have died in 1953 but his soul went marching on. UK acts of Parliament taking into state ownership the coal, gas, electricity and steel industries etc all typically included clauses obliging the politically appointed boards of directors to manage state industries in the "public interest".

What that meant was not made explict though the acts typically also empowered governments to issue directions to the boards, presumably to cover contingencies where conceptions of public interest might diverge. From time to time, UK governments did issue directives, usually to postpone price hikes at politically sensitive times or to require procurement of national products in preference to imports while leaving unresolved how the boards were to cope with any ensuing deterioration in commercial returns on operations.

At a stroke, the effect was to fudge accountability for running state-owned industries efficiently. Losses could always be attributed to delayed price hikes or the like of keeping plants going in an area with high local unemployment because either course was in the "public interest". One way or another, consumers paid through higher prices charged by state-owned monopolies or through higher taxes to pay for loss write-offs or subsidies.

It took decades before it came to be accepted that for the sake of better transparency and accountability governments should be required to pay over taxpayers' money to state-owned industries to compensate for losses incurred through compliance with political concerns. The fashion for privatising state-owned industries during the last two decades has, of course, abolished the problem of vague or ambivalent statutory remits altogether. With that came a realisation that governments can still enable or induce private companies to undertake some activity deemed by elected politicians to be in the "public interest" but through a set of freely negotiated contracts which make the whole exercise explicit and open to review by the courts if necessary.

The adoption *in recent years* of specific inflation rate targets by European central banks reflects changes in economics thinking since the benign but ambivalent targets were assigned by Congress to the FED in 1949. I think there have been three crucial steps in political thinking in the UK which lead to the present position.

First, the delayed digestion of the policy assignment literature, started by Tinbergen in 1952, with its conclusion that only a single policy objective is appropriately assigned to each policy instrument.

Wide appreciation of the significance of this by politicians in the UK probably only came through experience of operating monetary policy in the late 1980s when central bank interest rate decisions, actually made at that time by the Chancellor of the Exchequer (UK treasury minister) and conveyed to the Bank of England, were intended to achieve two distinct but conflicting policy objectives - constraining inflation while simultaneously attempting to ensure the exchange rate did not appreciate unduly during the UK's route to joining the European Exchange Rate Mechanism (ERM). The outcome of this conflict was that inflation accelerated and the UK did eventually join the ERM in 1990 but at an exchange rate that proved unsustainably high with the result that the UK was compelled to drop out of the ERM in 1992. However, there are still indications that some politicians of various hues have not entirely digested lessons from that episode.

The second strand was something of a forced recognition from the early 1980s that central banks in America and Britain were unable to effectively target the "money supply", in the short term at least. It came to be accepted that using interest rates as the explicit central bank policy instrument made better sense, with the banks applying open market operations in securities to ensure rate decisions had an effective impact on security yields. The specific assigned tasks of the Bank of England and the European Central Bank now are to constrain inflation by adjusting interest rates whenever the banks assess that that inflation downstream is likely to move outside its target range.

The third strand was the mounting research evidence through the 1980s that affluent countries with politically independent central banks were generally making a better job of constraining inflation while achieving lower rates of unemployment on trend. The transmission mechanism was from the effect on expectations of making central banks politically independent in setting interest rates. If governments could be leaned on through the electoral process to eventually bail out the consequences on unemployment of high pay settlements, the boards of independent central banks were much less susceptible.

As for policy relating to exchange rates and (un)employment, exchange rates were left to float while labour market measures, such as changes in welfare eligibility and better training opportunities, were intended to spur or ease the transition from unemployment to work. The implied prescription for unemployment is that while governments can act as facilitators, functioning labour markets determine employment and unemployment rates within frameworks of regulations set by governments.

In the Eurozone, with its single currency, the option of changing the exchange rates of national currencies has been closed off but the Euro still floats against other currencies in the foreign exchange markets. Early in 1999, the then German minister for finance made formal proposals to the US and UK governments to limit exchange rate variability of the Euro against the US Dollar and UK Pound but his proposals were not accepted. Europeans retain a deep nostalgia for fixed exchange rates.

Apologies for the long reply but I thought it interesting to explore lags between policy debates and implementation. Whatever the enabling legislation states, I believe the FED has been applying an inflation constraining policy, and properly so. The main criticism is about the asset-price bubble but then Greenspan did warn about "irrational exuberance" back in 1996. A policy dilemma with the FED's employment remit has not been apparent because NAIRU in America is relatively low compared with the Eurozone's. A dilemma for the FED could arise were NAIRU to increase but it is not at all clear what the FED - or any central bank - can do if that happens. Concerns have been raised about the prospect of a deflationary spiral ahead but recall in the present international situation the events that preceded what was called "Stagflation" in America and W Europe during the 1970s.

Posted by: Bob Briant (UK) on September 18, 2002 07:12 PM
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