Federal Reserve Chairman Alan Greenspan spoke yesterday at a breakfast sponsored by the National Italian American Foundation at Georgetown University. I was in attendance. Greenspan said gracious words about NIAF and presented a fascinating long-term view of changes in the economy. He spoke in clear and comprehensible language here, as opposed to the complex Greenspan-speak he employs when testifying before Congress on short-term trends.
In my more than 18 years at the Federal Reserve, much has surprised me, but nothing more than the remarkable ability of our economy to absorb and recover from the shocks of stock market crashes, credit crunches, terrorism, and hurricanesblows that would have almost certainly precipitated deep recessions in decades past. This resilience, not evident except in retrospect, owes to a remarkable increase in economic flexibility, partly the consequence of deliberate economic policy and partly the consequence of innovations in information technology.
Greenspan noted that for a century and a half, the federal government made little or no effort to affect aggregate demand. Then, after the Depression of the 1930s and the world war of the 1940s, the government moved aggressively to affect aggregate demand in order to produce full employment. It also imposed "heavy regulation."
Then, in the 1970s, the decade when Greenspan served as chairman of the President's Council of Economic Advisers, government began to deregulate transportation, communication, and financial services and to dismantle economic barriers and trade barriers.
As a consequence, the United States, then widely seen as a once great economic power that had lost its way, gradually moved back to the forefront of what Joseph Schumpeter, the renowned Harvard professor, had called "creative destruction"the continual scrapping of old technologies to make way for the innovative. In that paradigm, standards of living rise because depreciation and other cash flows of industries employing older, increasingly obsolescent technologies are marshaled, along with new savings, to finance the production of capital assets that almost always embody cutting-edge technologies. Workers, of necessity, migrate with the capital.
Through this process, wealth is created, incremental step by incremental step, as high levels of productivity associated with innovative technologies displace less-efficient productive capacity. The model presupposes the continuous churning of a flexible competitive economy in which the new displaces the old.
Economic flexibility was also increased by information technology and by financial innovations that Greenspan obviously understands far better than I do.
The bottom line:
Moving forward, I trust that we have learned durable lessons about the benefits of fostering and preserving a flexible economy. That flexibility has been the product of the economic dynamism of our workers and firms that was unleashed, in part, by the efforts of policymakers to remove rigidities and promote competition.
Although the business cycle has not disappeared, flexibility has made the economy more resilient to shocks and more stable overall during the past couple of decades. To be sure, that stability, by fostering speculative excesses, has created some new challenges for policymakers. But more fundamentally, an environment of greater economic stability has been key to the impressive growth in the standards of living and economic welfare so evident in the United States.
After the speech, I had a chance to ask Greenspan the question that I had thought of beforehand and that seemed even more relevant after his talk. The economy has more resilience today than it did in the 1970s. So are there metrics for measuring that resilience? We're trying to develop them, Greenspan said, but we haven't gotten there. "Obviously, there is something to be measured." (This is the one sentence I am sure I am quoting exactly, because it struck me particularly.) But, he went on, we don't have the equations yet.
Greenspan's Olympian view of the economy over decades and even centuries is surely worth pondering. The Economics 1 I learned at Harvard in 1964 said that Keynesian economics had all the answers: The course of progress in history is to move from less to more government regulation and government manipulation of the private sector economy, and today (that is, 1964), we have figured out just how to manipulate it.
Ten years later it was apparent that all that was wrong; but it wasn't apparent how the economy or economic policy could be fixed so as to perform better. The answer, according to Greenspan, turned out to be: Let free markets work with less regulation, and in time they would produce better financial mechanisms and information technologies. Interestingly, a case could be made from his remarks that the political marketplace worked, if unknowingly, to help produce these results. Greenspan made the point that presidents and politicians of both parties have moved toward deregulation. True: Jimmy Carter and Edward Kennedy played major roles in airline deregulation, for example. Ralph Nader was a force for deregulation, as were market economists like Milton Friedman. Lower taxes were largely a Republican contribution but not entirely: Bill Bradley and Dan Rostenkowski played critical roles in the 1986 tax law lowering rates and eliminating preferences. The political marketplace was sending signals that the results of heavy regulation and high taxation weren't acceptable, and politicians, Democrats as well as Republicans, responded to the signals in the political marketplace, as they usually but not always do.
The danger that Greenspan implicitly warns against is that the politicians, or some of them, will forget the lessons of the past 30 years. He warned against protectionism, but Democrats in the House were now in lockstep opposition to the Central American Free Trade Agreement. Democrats in their all-out opposition to George W. Bush seem to have forgotten some of their own policy successes in the 1990s and before. I think one of the purposes of Greenspan's speech was to remind them.
Economics is the one academic discipline that has clearly moved to the political right over the past long generationand, perhaps not coincidentally, it is the one social science most closely disciplined by real-world data. It turns out that history doesn't always move left, away from markets and toward government regulation and control. In Greenspan's version, history moved left because of perceived market failure in the 1930s and perceived government success in World War II, but when the resulting arrangements stopped working well, history moved to the rightto markets, flexibility, resilience. We have learned a lot about the economy and economic policy since the 1970s, and no one has taught us more than Alan Greenspan. I wish him luck on developing metrics for resilience.