Exit The Maestro: The Economy Owes Much To His Deft Handling Of Inflation
Alan Greenspan is a man of numbers. So to tell the story of the central banker many consider to be the nation's greatest ever, let's begin with them: 18, 5.55, 3, 2. Greenspan has spent 18 years as chairman of the board of governors of the Federal Reserve System, the second-longest term in the Fed's 92-year history. During his tenure, the unemployment rate averaged 5.55 percent, and the average annual inflation rate was 3 percent. Compare that with 6.85 percent unemployment and 6.5 percent inflation over the prior 18 years. Finally and most important, there's the number 2: two mild recessions during his term, or the longest economic expansion in U.S. history. Impressive, considering that from World War II until the man known as the maestro took the economy's helm, recessions occurred every six years or so.
Of course, numbers don't tell the whole story, even that of an economist known to digest reams of them in his bathtub. Greenspan's genius, in the minds of many who follow the Fed, was his ability to inspire confidence in the markets, nurture economic prosperity through multiple financial crises, and build upon the inflation-crushing success of his predecessor, Paul Volcker.
"Prop him up." Indeed, faith in Greenspan as a miracle worker ran so high that during the 2000 presidential campaign, Sen. John McCain quipped that "if Mr. Greenspan should happen to die, God forbid . . . I'd prop him up and put a pair of dark glasses on him and keep him as long as we could."
With Council of Economic Advisers Chairman and former Fed governor Ben Bernanke now nominated to replace Greenspan, who will leave the Fed on January 31 and turn 80 five weeks later, that won't be necessary. Instead, expect a long goodbye marked by glowing tributes bordering on worship.
And yet, despite all the accolades, criticisms linger, even among those who acknowledge the astounding job he has done in stewarding the enormous--and enormously complicated--U.S. economy through perilous straits.
Principal among them is the complaint that Greenspan did nothing to deflate the stock market bubble of the late 1990s. Greenspan argues that nothing should be done by the Fed to prick asset bubbles. "Relying on policymakers to perceive when speculative asset bubbles have developed and then to implement timely policies to address successfully these misalignments in asset prices is simply not realistic," he reiterated recently. The best solution is a flexible economy, Greenspan says, and the Fed can work to contain the damage after the bubble bursts. The Greenspan Fed did just that after the 2001 meltdown of technology and telecom stocks by taking interest rates to 45-year lows. Yet that policy, say critics, merely set the stage for another bubble to appear in housing, fueled by mortgage rates below 6 percent. "Until the aftermath of the housing bubble is determined, Alan Greenspan's track record will not be carved in stone," says Jim Stack, president of InvesTech Research.
Greenspan relied on his personal judgment to formulate monetary policy. As successful as that method has proved, it presents a formidable problem for his successor. "When the next leader of the Fed takes his seat behind the chairman's desk and opens the top drawer in search of Alan Greenspan's magic formula, he may be sorely disappointed," wrote Princeton economist Ricardo Reis and former Fed Vice Chairman Alan Blinder in a paper presented this summer at the Fed's annual Jackson Hole, Wyo., conference.
And some say Greenspan was lucky. He encountered no great oil shocks like the whoppers his mentor Arthur Burns and Volcker had to contend with. He also assumed leadership of the Federal Reserve just a few years into what economists call the Great Moderation, the period beginning around 1984 when the volatility of several important macroeconomic variables began to decrease significantly. Also, Greenspan himself would point to large pools of labor in Asia that have come online over the past two decades as the reason for a slowdown in the increase of labor costs and the resulting fall in the rate of inflation.
Crises. Greenspan showed great deftness, though, in dealing with the 1987 stock market crash, a savings-and-loan banking catastrophe, currency crises in emerging markets, a Russian default, the collapse of one of the world's largest hedge funds, the terrorist attacks of Sept. 11, 2001, and a series of corporate scandals that severely shook investor confidence during his term. "The way the Greenspan Fed responded to not only the Asian crisis but also to 9/11, the readiness to coordinate with other central bankers around the world, that has been pretty impressive," says Edward George, former governor of the Bank of England.
Greenspan also had the politician's touch, certainly a plus in Washington. His first stint as a power player was as chairman of the Council of Economic Advisers. As an economic forecaster in New York, he had taken time out to work on Richard Nixon's 1968 campaign and had impressed the candidate with his knowledge of and ability to explain economic issues. Six years later, Nixon asked Greenspan to become his top economic adviser. Oddly enough, he ended up working for President Gerald Ford, as Nixon resigned the night of Greenspan's nomination hearing. His swearing-in ceremony in the White House Cabinet Room was attended by the two women to whom he was devoted, his mother, Rose Goldsmith, and philosopher and novelist Ayn Rand. For years in New York, Greenspan had been a disciple of Rand and her strict theory of rational self-interest.
Rising unemployment and a 12 percent inflation rate in 1974 made battling stagflation the top priority of the president's new man. Greenspan talked Ford into a tax-cut stimulus, the efficacy of which was debatable. Other White House measures, like an effort to enlist citizens in the fight against inflation by printing millions of buttons emblazoned with the slogan "Whip Inflation Now," or WIN, bore little fruit. More notably, Greenspan was the architect of the 1975 federal bailout of New York City. But probably his greatest achievement during his first two-year stint inside the beltway was to forge relationships with powerful politicians such as James Baker III and Ford's chief of staff, Dick Cheney, and to hew inroads into influential reaches of Washington society, which included dating celebrity journalist Barbara Walters. It all came to an abrupt end the day Jimmy Carter was sworn in, and Greenspan returned to New York.
Ten years later, President Reagan wanted his own man at the Fed--he had inherited Volcker, a Democrat, from Carter. Baker, by then Reagan's treasury secretary, immediately recommended Greenspan. "I don't recall that we considered anyone else," says Baker. "We felt that Greenspan would be acceptable to Wall Street and to economic commentators, and there was no real Democratic opposition to him."
Gradualist. Greenspan's start at the Fed was rough. Two months after taking office, he faced Black Monday, when the Dow Jones industrial average dropped 23 percent in a single session. Some investors and economists blame Greenspan for the crash, as he began his Fed term with an abrupt series of interest rate hikes. Regardless of who caused the crash, the Fed's reaction was right. It quickly provided liquidity and persuaded banks to make loans. All in all, the experience turned Greenspan into a gradualist, says Stack: "He learned quickly not to try to drive the economy like a sports car." Greenspan has remained so ever since, as evidenced by the series of 11 consecutive quarter-point interest rate hikes (with one more likely this week) that the Fed has undertaken over the past 16 months to raise the benchmark federal funds rate from 1 percent to 3.75 percent.
The 1987 crash most likely reinforced Greenspan's willingness to learn on the job. The chairman himself summed it up recently at Jackson Hole in his famously circumlocutory manner: "Despite extensive efforts to capture and quantify what we perceive as the key macroeconomic relationships, our knowledge about many critical linkages is far from complete and, in all likelihood, will remain so."
The 1987 episode laid the groundwork for what many Fed watchers consider Greenspan's greatest triumph. During the mid-1990s, the U.S. economy was sailing, with inflation contained and unemployment creeping ever lower toward 5 percent. Yet those conditions troubled economists, many believing that unemployment could not remain below 6 percent for long without stoking inflation. By 1997, that conviction was putting enormous pressure on the Fed to raise rates.
Greenspan, however, sensed something was different. Although it wasn't yet showing up in the economic data, he speculated that the widespread adoption of information technology, among other factors, was leading to an increase in productivity among American workers. If so, the relative scarcity of available labor would not necessarily push prices higher.
"The staff didn't believe it. I didn't believe it," says Laurence Meyer, a Fed governor at the time. "The chairman was the only one who believed there was a productivity acceleration. It was a brilliant call."
As a result of Greenspan's insight, the Fed did not raise rates, allowing the unemployment rate to safely fall below 4 percent. "Greenspan has a medley of greatest hits, but to me, this was his greatest," says Alan Blinder.
The downside, though, was that already enthusiastic investors became positively euphoric. Even though Greenspan's Fed took no direct action to curb the late-1990s market hysteria, the chairman did speak out. As early as December 1996, he asked, "But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions . . . ?" The line, part of an otherwise unremarkable awards dinner speech, sent the Dow down 145 points soon after the next day's opening bell.
Laissez faire. The markets rebounded that day and proceeded to scale new peaks until the 2000 crash. Other than a bit of additional jawboning, the Fed made little effort to bring the stock market back from the brink. It would seem that although the Fed chairman's economic philosophy had branched out considerably since his days as a dogmatic libertarian, at root he has remained a disciple of the late philosopher Rand.
In between reading the economic tea leaves, the Fed chairman took time out to marry his longtime companion, NBC political correspondent Andrea Mitchell. They had been a Washington item for over a decade, and in April 1997, Greenspan took the plunge. "It was rational exuberance" that prompted him to propose, Mitchell joked at the time.
Greenspan's tenure largely coincided with the longest and strongest economic expansion in U.S. history. Many factors played into that, including industry deregulation that began under Carter, the conspicuous consumption of the baby boomers, and the end of the Soviet Union and the emergence of China. But considerable credit must go to the Greenspan Fed, which kept the boom on track through a soft landing it engineered in 1994 in the face of rising inflation, the 1997 productivity insight, and sound responses to various calamities, including an emerging-market collapse and the demise of hedge fund Long Term Capital Management.
Greenspan also formed a beneficial partnership with President Clinton and his treasury secretary, Robert Rubin, who hailed from Wall Street. Clinton described the relationship to U.S. News: "The basic bargain was if I pursued the path to fiscal responsibility, [Greenspan] would respond by trying to keep interest rates down . . . and then we could do all the things we had to do to manage America out of the Cold War economy into the 21st-century economy."
Greenspan's periodic trips to testify on Capitol Hill became a Washington spectacle, with lawmakers seeking his advice and approval on all manner of legislative issues, from education to taxes. And though the chairman often talked circles around his inquisitors--"If I say something which you understand fully in this regard, I probably made a mistake," he once told a member of the Senate Banking Committee--he always left them smiling. "A big part of the job is to satisfy the public, the markets, the Congress, and the White House, and at the same time to maintain his independence. He did that very well," says Allan Meltzer, professor of economics at Carnegie Mellon University and historian of the Federal Reserve.
Greenspan's Fed also reached out to the public by shining a light on the inner workings of the once secretive institution. When he arrived, the Fed didn't announce monetary policy decisions; Wall Street had to watch rates to divine the central bank's latest action. Eighteen years later, the Fed not only announces rate changes; it gives a statement explaining them and its future leanings, and Fed meeting minutes are publicized.
The gradualistic Greenspan has been the right person for the evolving economy of the past two decades. Indeed, it's possible that he has been too good at his craft. "In perhaps what must be the greatest irony of economic policymaking, success at stabilization carries its own risks," Greenspan said last month. Prolonged stability leads investors to forget about risk, which breeds the "irrational exuberance" that inevitably leads to corrections. But now it will be a new Fed chairman who has to deal with the problem.
"A driver might tap the brakes to make sure not to be hit by a truck coming down the street, even if he thinks the chances of such an event are relatively low."
Before the Senate Banking Committee, July 1997
"But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions...?"
A speech that later came to symbolize an era, Dec. 5, 1996
"If I say something which you understand fully in this regard, I probably made a mistake."
Before the Senate Banking Committee, June 20, 1995
This story appears in the November 7, 2005 print edition of U.S. News & World Report.