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Mr. Fixit

Unlike Burns, who wrote seriously if controversially about economic theory, Greenspan was not drawn to an academic career. He left Columbia early to become an economic consultant for the Conference Board—a research group sponsored by large corporations. But from Burns, he absorbed many of the laissez-faire principles that characterized his early work. At the time, the ideas of John Maynard Keynes had many adherents in the US. Keynes’s The General Theory of Employment, Interest and Money, published during the Depression, argued that economies could reach a state of equilibrium—that is, balance between the supply and demand of both products and money—at high levels of unemployment and low levels of cap-ital investment. An economy, Keynes argued, may not be able to deviate from this equilibrium without government intervention, and so at times government deficits are required to stimulate demand for products and induce corporations to invest more aggressively. Arthur Burns was contemptuous of Keynesian ideas. To him, inflation was throughout history a more insistent economic problem than recession. Both Woodward and Martin cite the same anecdote to explain Greenspan’s devotion to laissez-faire principles. Woodward writes:

What causes inflation?” Burns once asked his students in a seminar. Everybody in the room got a turn to provide an answer and then Burns revealed his own.

Excess government spending causes inflation,” he said. That lesson was not to be lost on Greenspan. Deficits create more money to chase the same amount of goods—a classic precursor to inflation.

Such a statement is at best half right. Notwithstanding the sophisticated criticisms that have been made of Keynesian fiscal policy, many economists still believe that it can provide an important, noninflationary stimulus to the economy when unemployment is high. Neither Woodward nor Martin look deeper for explanations of Greenspan’s ideology; nor do they explore the controversies among economists over the uses of such fiscal stimulus.

By the early 1950s Greenspan was a practicing economist without a Ph.D., who specialized in collating and analyzing information about different American industries. While working at the Conference Board, he started a small private consulting service on the side. In 1952, on a blind date, he met an attractive Canadian woman, Joan Mitchell, and they were married within a year. Mitchell was an aspiring painter and an avid follower of Ayn Rand, author of The Fountainhead and, later, Atlas Shrugged. Greenspan was initially skeptical about Rand’s ideas; but after he and Mitchell had their marriage annulled a year later, Greenspan drew closer to Rand. He began to contribute to the group’s magazine, The Objectivist, where he published articles on the virtues of profits, self-interest, and the gold standard.

Greenspan’s interest in the detailed workings of business fit with Rand’s view of the entrepreneur as hero. In the early Sixties he got a job with a small private consulting firm called Townsend-Skinner, which eventually became Townsend-Greenspan. The firm was especially adept at ferreting out data on specific industries to help them make decisions about budgeting, investment, and strategy. A point not clearly made in these books, however, is that Townsend-Greenspan was a politically conservative firm in an era that was turning increasingly liberal. To successful businessmen, Greenspan was a competent economist, highly familiar with government and industry data, who was as skeptical of government interference as most of them were. In the 1960s, first-rate economists were mostly liberal and Democratic.

Greenspan had found an attractive niche. The press quoted him frequently, partly because he was articulate, but also because he was one of the relatively few economists who seemed a plausible spokesman for the conservative point of view. Arthur Burns was now a Nixon adviser, as was the lawyer Leonard Garment, who had played in Greenspan’s jazz band. They invited Greenspan to join Nixon’s presidential campaign, for which he was in charge of formulating economic policy; he also coordinated budget issues during the transition. But he turned down a job as budget director to return to Townsend-Greenspan.

Greenspan was never far from Washington, however. He was making good money at Townsend-Greenspan, moved into New York’s luxurious United Nations Plaza, and served on several important federal commissions in the late 1960s and early 1970s. When Nixon imposed price controls in 1971, Greenspan said he was firmly opposed. But in 1974, he was offered the job of chairman of the Council of Economic Advisers. Martin writes that Greenspan was hesitant to abandon the several hundred thousand dollars a year he was earning to take the $42,500-a-year job. But he did, and took over the post when Gerald Ford became president.

There were few economic victories in the 1970s. The recession of 1974 and 1975 was the worst since World War II. But during this period, Greenspan won many friends in Washington through a combination of sincerity, equableness, and articulateness. He became close to President Ford, which provided him a firm base from which to expand his contacts. He was a familiar figure in Washington’s social life, frequently escorting Barbara Walters. Years later, he married the NBC news correspondent Andrea Mitchell.

Greenspan was at ease with power and money, but he moved less securely among serious economists. He returned to NYU to pursue his doctorate when he was at Townsend-Greenspan. Though he was awarded a Ph.D. in 1977, he did not complete a conventional dissertation. Instead, he submitted published articles and other writings, some of them for publications such as Business Economics, which would not have met the scholarly standards for most economics departments. He neither collected original data nor undertook fresh mathematical analysis of existing data—two central tasks of the professional economist’s trade. Greenspan’s talent was to bring together available information that tells us something about the day-to-day workings of an industry or of the economy as a whole. Whether he had his own systematic view of how the economy functions was never clear.

What Greenspan was especially good at was helping to resolve practical problems, such as his work in Washington in the administration of the military draft in the early 1970s, on the New York City crisis in the 1970s, when he was chairman of the Council of Economic Advisers, and later as head of President Reagan’s Social Security Commission in the 1980s. He had a few conspicuous lapses of judgment, for example when he recommended that Gerald Ford be Ronald Reagan’s running mate after he had already served as president. As a consultant, he was enthusiastic about the operations of Charles Keating, the head of the Lincoln Savings & Loan. The company was soon convicted of fraud.

These missteps did not seriously damage his reputation for sober judgment; but to the combination of slow economic growth and high inflation in the 1970s known as stagflation, he brought no imaginative solutions. Under Greenspan’s chairmanship of the council, the American economy continued to founder.

2.

How did Greenspan achieve such a high reputation as Federal Reserve chairman? The first thing to remember is that Federal Reserve chairmen are typically celebrated even when they fail. The Federal Reserve was created by Congress in 1912 as an independent central bank that would maintain a strong currency and would remain relatively free of short-term political influence. Just because its chairmen are not elected and are not involved in party politics, they have an aura of independence and objectivity. Control over interest rates gives them extraordinary power, and people throughout the country and the world hang on their pronouncements.

The Fed’s methods, moreover, have become increasingly refined. Commercial banks are required to maintain as reserves a proportion of the loans they make. To meet this requirement, they regularly loan to and borrow from one another. The Fed’s main policy instrument is to buy and sell government securities through its Federal Open Market Committee (FOMC) in order to set the interest rate at which the banks lend and borrow—the so-called federal funds rate. When the Fed buys securities, providing more money to the market, the Fed funds rate falls; when it sells, withdrawing funds from the market, the Fed funds rate rises. Usually this single interest rate will affect most other rates in the financial markets, such as rates on bonds—the longer-term loans that investors make to corporations and governments.

The chairman traditionally has the power to determine these rates, but he must officially convince the other members of the Federal Reserve Board to support his decision. Paul Volcker was said to have run the Fed like a one-man show. Greenspan has been more collegial, but most observers believe he generally gets his way. Fed chairmen are in fact among the most powerful unelected officials in the world.3

Volcker, Greenspan’s direct predecessor, was probably the most admired of Fed chairmen by the financial community until Greenspan’s golden years in the late 1990s. A Democrat with a doctorate from Princeton in economics, Volcker was a banker appointed to the chairmanship in 1978. By then, inflation had reached double digits and Volcker was determined to tame it once and for all. Under him, the prime rate, the interest rate banks charge their most solid borrowers, rose to 21 percent, and most experts believe his tight money policies resulted in the steep 1982 recession. By 1983, inflation was diminishing rapidly. Volcker eased interest rates and opened the way for a period of rapid growth, stoked further by Reagan’s enormous tax cuts.

To many, including Reagan supporters, Volcker’s monetary policy was still too restrictive, and he resigned after his second term. In view of Greenspan’s experience and his Republican loyalties, he was a natural choice. By August 1987, the age of Greenspan had begun.

Greenspan evidently wanted to show that he was every bit the inflation fighter that Volcker was. In September, only three weeks after he took office, he arranged a 0.5 percent hike in the Fed funds rate. But only two months later, he faced one of his biggest crises. On Monday, October 19, 1987, the Dow Jones Industrial Average fell by more than 22 percent, or 508 points. Greenspan was immediately sensitive to the dangers that widespread losses could have for the entire financial structure. But according to Woodward’s account, it was Gerald Corrigan, president of the New York Federal Reserve, who sounded the alarm and recommended emergency measures. To his credit, Greenspan did not resist. The Fed issued a statement saying it would supply ample credit to support the financial system. Then Corrigan took to the phone to make sure banks were lending enough money to cover the enormous losses.

A coordinated rush by central banks around the world to provide liquidity, whether in cash transfers or credit, had the effect of setting a floor under stock prices, and eventually the financial markets returned to normal. The Fed funds rate was reduced by about one full percentage point over the next few months. The surge of liquidity provided fuel for the economy for another year and a recession was nowhere in sight. In fact, Greenspan started to worry about the return of high inflation again. The confidence of investors in the new Fed chairman was established.

Almost at once, then, two themes that dominated Greenspan’s tenure were apparent. First, he feared giving any impression to the markets that he was relenting on the battle against inflation. Second, when financial crisis struck, and it did so with consistency, he quickly provided substantial funds to protect the system, regardless of the inflationary consequences. When calm was restored, he returned to his inflation-fighting ways.

Greenspan was also careful to keep the central bank independent of political interference from the White House. The basic assumption of virtually all central bankers is that any visible sign that they are easing credit in response to political pressures undermines market confidence. William McChesney Martin, the chairman between 1951 and 1970, had a running battle with the populist congressman Wright Patman, who believed that the Fed invariably kept interest rates too high to protect bankers and lenders in general. This theme in American politics was at least as old as Alexander Hamilton’s first national bank. Arthur Burns was widely accused of reducing interest rates to help get President Nixon reelected in 1972; his reputation never recovered.

In general, Greenspan resisted pressure from the Bush White House to reduce interest rates. The Clinton administration was more circumspect publicly, but the President was clearly disappointed that Greenspan did not push rates down further in the mid-1990s. Clinton eventually nominated the Princeton economist Alan Blinder, a Democrat whose views leaned toward Keynesianism, as vice-chairman, and this seemed a gesture aimed at softening the Fed’s positions. But Blinder was quickly frustrated by Greenspan’s domination of the board as well as the press, and he resigned eighteen months later.

In fact, Greenspan was overly concerned with inflation in these years, and surely reacted too slowly to impending weakness in the economy in 1990. Woodward quotes him as saying in 1989, “I frankly don’t recall an economy that at least on the surface looks more balanced than the one that we have.” But the 1990–1991 recession was serious and sent unemployment rates above 7 percent again, rising from 5 percent a year earlier. Bush reappointed Greenspan, nevertheless; but he said in a 1998 television interview that he thought Greenspan’s tight policies had cost him reelection.

The Clinton administration also openly supported Greenspan, although the President was disappointed that he did not cut rates further after Clinton had made the politically difficult decision to increase taxes in 1993. Among Woodward’s most interesting contentions is that Greenspan and Clinton privately agreed that if the administration could pass a budget that reduced the federal deficit, Greenspan would be more accommodating. If Greenspan was concerned that the White House would interfere with the Fed, he seems to have had no qualms about intervening to influence the President’s budget. According to Woodward, he made a similar deal with Bush in 1990, when Bush also increased taxes.

As the economy started to grow in 1994 and 1995, however, Greenspan again began to get aggressive about controlling inflation. In his continuing study of data, Greenspan insisted that he saw the incipient signs of renewed inflation. In my view, however, he followed the lead of bond investors, who were pushing up interest rates on bonds because they anticipated renewed high inflation. High bond rates dampened capital spending and also affected home buying because they tended to influence mortgage rates.

Were these inflationary expectations justified? There is good reason to doubt it—or at least to suggest that Greenspan could have done more to test his assumptions. During the 1990s, workers, after a couple of decades of high unemployment rates, were no longer confident enough to demand significant wage increases. Consumers resisted price increases. Much of American business had been reorganized to make more efficient use of labor. If Greenspan had kept interest rates low and inflation still remained subdued, bond investors would eventually have learned that their fears of inflation were unjustified. But Greenspan doubled the Fed funds rate in 1994 alone from 3 percent to 6 percent, and rates on bonds went higher as well. This put bond investors’ fears about inflation to rest. But it slowed the economy and sent the unemployment rate back up.

Greenspan turned to a policy of easier credit in 1995; in 1996, he resisted pressure from some Federal Reserve Board members and refused to raise the Fed funds rate. Some believed he was maneuvering for reappointment by Clinton; but Woodward writes that Greenspan began to believe that information technology was enabling the nation’s productivity to rise faster. More hourly output per worker—that is, higher productivity—meant that business could pay higher wages with-out raising prices and generating the higher inflation that usually comes with more rapid growth and tighter labor markets.

If Greenspan had a new faith in information technology, however, why did he raise the possibility in a speech later in 1996 that the high stock market might have been exhibiting “irrational exuberance?” Stock prices plunged on his remarks. If there truly was a technological miracle that enabled corporations to pay higher wages and still improve profit margins, then there was little reason to believe stocks were too high. In fact, the Dow Jones Industrial Average, at 6,000 in 1996, would almost double by the year 2000.

Greenspan’s contribution to the economic boom of the late 1990s was that between 1996 and mid-1999 he barely raised interest rates at all, despite a rapid increase in the rate of growth and a falling unemployment rate. By 1999, the unemployment rate had fallen to nearly 4 percent. Two years earlier, most economists believed any rate below 5.5 percent would produce inflation. Greenspan openly and even aggressively defied the conventional wisdom.

In my view, the reasons for this were based less on systematic economic analysis than Greenspan likes to convey. Most obviously, a series of rolling financial crises that began in Asia in 1997, extended to Russia, and then to the bankruptcy of the enormous hedge fund Long-Term Capital Management forced Greenspan to adopt easy-money policies to stop further bleeding.

But second, inflation itself was nowhere in sight. Except for an occasional blip, interest rates also remained low. One did not need a grand vision, such as the power of a New Economy, to explain lower inflation. Many more workers were actually available to work than the employment data suggested; and for the most part they were hesitant to ask for big wage increases. There were exciting new computer-related products on the market, and most of these were made by new industries that were themselves very productive. Finally, the dollar was very high, which kept import prices low. Without a sign of rising inflation or inflationary expectations among bond traders, Greenspan, the inflation watcher, was willing to keep interest rates down; and both the economy and stock prices roared ahead.

What was disturbing about Greenspan’s pronouncements on a New Economy was that they intensified speculation in the market. Soaring stock prices are what made the Fed chairman the cult figure he became. The presumption that Greenspan had a special knowledge about a new industrial revolution that others did not was comforting to those paying prices for stocks that were unprecedentedly high. But the chairman never presented a comprehensive or systematic analysis of his point of view. Some members of his staff came up with convincing research that capital investment in high technology had reached a point where it was having large and widespread effects.4 But this did not mean that a revolution had taken place. Firm evidence of a “new economy” was simply less apparent than Greenspan suggested.

Despite Greenspan’s optimism, he began to raise rates again in mid-1999. There was no serious sign of renewed inflation but bond rates were rising again and, in my view, this caused him concern as it had in the past. The very stock market speculation that Greenspan fed with talk of a New Economy was also haunting him. If the stock bubble burst, it could rapidly extinguish both consumer and business confidence. Perhaps it was time cautiously to apply the brakes.

There is no easy way to fine-tune an economy. Whatever the causes, Nasdaq stocks fell precipitously beginning in the spring of 2000, and the economy slowed noticeably later in the year. Greenspan began to reverse course rapidly early this year by cutting the Fed funds rate several times.

In truth, there are serious imbalances in the US economy. The dollar is disturbingly high. The trade deficit keeps growing. Consumers have borrowed in record amounts, especially against their homes. America’s savings rate is low, even occasionally negative. The millions of people who thought their investments in mutual funds were equivalent to savings were victims of an illusion. For all the rapid economic growth of the 1990s, incomes remained radically unequal, which has something to do with the slow economic growth of the preceding two decades. Greenspan’s earlier policies of tight credit may well have contributed to that result.

One of the more dangerous new faiths is that Greenspan could always save the day, as he did in 1987 and again during the financial crises of 1997 and 1998. Many investors came to believe that there was a floor under stock prices, and Greenspan did too little to dissuade them. But monetary policy’s influence can be much more limited in its effects than it was during these episodes. In a sinking economy, even very low interest rates may not be sufficient to stimulate demand for capital or consumer goods.

Greenspan’s policy errors do not necessarily undermine his overall record. He has been a man of largely consistent principle in his efforts both to control inflation and avoid financial crises. He has had, I think, no illusions about his having exceptional powers of analysis, even if he likes all the attention. The economy may yet recover and thrive. What has been most troubling about Greenspan has been his intrusions into legislative and tax policy, particularly in supporting George W. Bush’s tax cut, and his romantic, promotional view of the “New Economy” well before the evidence was in. Behind the mask of prudence, he was too ready to accommodate the new president and too eager to celebrate an economic transformation whose reality remains little understood.

  1. 3

    Among the Federal Reserve’s other tools, it sets the discount rate at which banks can borrow funds directly from the Fed itself, mostly in emergencies. It also sets the proportion of loans that banks must hold as reserve requirements. But the operations of the FOMC are its main tool, setting the Fed funds rate and indirectly controlling the amount of money supplied to the nation.

  2. 4

    Stephen D. Oliner and Daniel E. Sichel, “The Resurgence of Growth in the Late 1990s: Is Information Technology the Story?,” in The Journal of Economic Perspectives, Vol. 14, No. 4 (Fall 2000).

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